Assume this is a closed economy a) What are investment and savings? b) Show the relevant algebra...

Question:

Assume this is a closed economy

Output $800
Consumption 640
Government revenue 80
Government expenditure 120
Investment
Savings

a) What are investment and savings?

b) Show the relevant algebra and the calculations that you used for each one

Closed Economy:

In economics, a closed economy is defined as a country which is not opened to trade (no exports nor imports). These countries are self-sufficient and provide with all the necessary goods or services produced within the country to the domestic consumers.

Answer and Explanation:

Assuming a closed economy, the GDP (output) equation is the following:

{eq}Y= C+I+G {/eq}

Where,

  • Y= output/GDP
  • C= consumption
  • I=investment
  • G= government spending

If we rearrange the previous formula to solve for I (investment), the equation would look as follows:

{eq}I=Y-C-G {/eq}

Please note that the left side of the equation (Y-C-G) is equal to national savings, which complies with the identity that states that national savings is equal to investments (S=I) in a closed economy.

Knowing this, we can solve the investment equation, that will provide us with the investment (I) result and as a consequence the savings (S) result.

{eq}I=$800-$640-$120 {/eq}

{eq}I=$40 {/eq}

Therefore, investment is $40 which is equal to savings that is $40 (based on the identity S=I in a closed economy).


Learn more about this topic:

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Overview of the Gross Domestic Product

from CLEP Social Sciences and History: Study Guide & Test Prep

Chapter 59 / Lesson 2
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