Assume that in a small open economy the following describes investment demand, private saving, and the government budget deficit.
I = 2400 - 125r
S = 1750 + 75r
T - G = -350
Suppose that the foreign interest rate is at 4.8 percent
a. Is the economy borrowing from or lending to the rest of the world? How much is the amount of borrowing or lending?
b. Suppose that the government budget deficit is cut by 200. Is the economy now borrowing from or lending to the rest of the world? How much is the amount of borrowing or lending?
The Leakages/Injections Approach to Equilibrium
LEAKAGES = INJECTIONS
For equilibrium Y = AE
Y = C + S + T and AE = C + I + G + EX - IM
C + S + T = C + I + G
S + T = I + G
T - G = I - S
We substitute the conditions into the equation:
-350 = (2400 - 125r) - ...
The Leakages/Injections Approach to Equilibrium is applied.