Discuss the three important economic relationships that can be derived from this expression related to the definition of GDP and explain each carefully.
The expression above depicts two different ways to come up with real GDP for a country. The left side of the expression explains expenditure side of computing real GDP which can be rewritten as: y = c + i + g +x – m In real terms, it could be said that real output (y) is equal to real aggregate expenditure (c + i + g + x – m). The right side of the equation depicts how to determine real GDP by the total income all people within a certain economy. This equation is written as: y = c + s + t
If we combine both equations, we can rewrite the formula for savings (s) in the following two ways:
s = i + (g – t) + (x – m)
This shows that savings must be matched by the uses of savings, investments, government deficit, and net exports. It also points out the “crowd out” effect where by increased government spending will decrease private investment due to the fact that the amount of savings is fixed. The graph below shows how the aggregate demand curve changes with increase in government spending in the short term and the long term.
s – (g – t) = i + (x – m)
This equation, derived from calculating GDP, shows how domestic savings, s – (g – t), is balanced by the demand for saving, i + (x – m). It also illustrates how interest rates are determined.
The final key relationship that can be found from manipulating the GDP equation is the following: s – (g – t) – i = x – m
s – (g – t) – i = NCO
x – m = NX
NX = NCO
This equation implies that net exports must equal net capital outflow (NCO). Net capital outflow is net flow of funds invested to foreign countries. A positive NCO means that a certain country invests more abroad then foreign countries invest back into it. A country with...