Question

A country finds itself in the following situation: the government budget surplus is 2% of its GDP; private savings is 30% of GDP; and physical investment is 33% of GDP. Based on the national saving and investment identity, if private savings fall to zero, what will happen to this country's current account balance?
A. deficit increases from 2% to 32% of GDP
B. deficit increases from 1% to 31% of GDP
C. surplus of 1% drops to deficit of 29% of GDP
D. surplus of 2% drops to deficit of 28% of GDP

Answer 1

Answer:

B. deficit increases from 1% to 31% of GDP

Explanation:

We know,

Based on the national saving and domestic investment,

Trade surplus = Private savings + Public savings - Physical (Domestic) Investment

Given,

Trade surplus (Government budget surplus) = 2% of GDP

Private savings = 30% of GDP

Public savings = 0% of GDP

Physical investment = 33% of GDP

Therefore,

2% of GDP = 30% of GDP + Public Savings - 33% of GDP

2% of GDP = -3% of GDP + Public Savings

Therefore, Public savings = -1% of GDP

It means there is a trade deficit of 1% of GDP.

Now, if the private savings is falling down to "0", the deficit will further. According to the formula

Trade deficit = 33% of GDP - 2% of GDP

Trade deficit = 31% of GDP

Hence, the deficit will increase from 1% to 31%.