Question

In a period of trade deficit, if domestic investment rises by $50 billion, private savings increases by $10 billion, and public savings decreases by $10 billion, then __________________.

Answer 1

If domestic investment rises by $50 billion, private savings increases by $10 billion, and public savings decreases by $10 billion, the trade deficit would increase by $50 billion.

Step-by-step explanation:

In a period of trade deficit, if domestic investment rises by $50 billion, private savings increases by $10 billion, and public savings decreases by $10 billion, then the trade deficit would increase by $50 billion.

This can be explained by the national savings and investment identity, which states that savings equals investment. When domestic investment increases, it means that there is a higher demand for financial capital, leading to an increase in the trade deficit as the country needs to borrow more from abroad to fund the investment.

The rise in private savings by $10 billion offsets part of the increase in the trade deficit, but the overall result is still an increase in the deficit by $50 billion.

Answer 2

When domestic investment rises without a sufficient increase in private and public savings, a country's trade deficit will increase by the amount of the shortfall, reflecting a higher need for foreign financial capital.

Step-by-step explanation:

In a period of trade deficit, if domestic investment rises by $50 billion, private savings increases by $10 billion, and public savings decreases by $10 billion, then the trade deficit will increase by $50 billion. The savings and investment identity in economics tells us that domestic investment (I) must equal domestic savings plus inflow of foreign capital—which is reflected in the trade deficit (exports minus imports, or X - M). According to this identity, if domestic investment rises and private savings do not increase enough to cover this investment, the shortfall needs to be met by increased inflow of foreign capital, leading to a larger trade deficit.

Applying this to the scenario provided, the rise in domestic investment ($50 billion) minus the increase in private savings ($10 billion) plus the decrease in public savings (-$10 billion) results in a $50 billion increase needed in foreign capital, which would mean a higher trade deficit. This happens because domestic savings (private and public combined) has increased by $0 billion overall ($10 billion increase in private savings and $10 billion decrease in public savings), which does not match the rise in domestic investment.