In an open economy, the government deficit is 600 and saving exceeds investment by 500, so in equilibrium the trade deficit (IM − X) must be
A)100
B)200
C)300
D)700

Question

Quizplus · Accepted Answer

In an open economy, the national income identity is given by Y = C + I + G + (X - IM), where Y is national income, C is consumption, I is investment, G is government spending, and (X - IM) is net exports (exports minus imports). When the government deficit (G - T, where T is taxes) is 600 and saving exceeds investment by 500, it implies that the domestic economy is lending 500 more than it is borrowing. For the economy to be in equilibrium, this excess must be matched by a trade deficit of 100, meaning the country imports more than it exports by 100 units. This is because the excess domestic saving is used to finance the government deficit and the trade deficit.

In an Open Economy, the Government Deficit Is 600 and Saving