Principles of Macroeconomics / Unit 7 MAC 0609 worked example, 60 to 90 seconds
Applying the Identity
The idea
Rearranged, the identity explains the trade balance: the trade deficit equals investment minus private saving minus the government surplus. Hold every term but one fixed and read off the result. If investment rises with saving unchanged, the extra funds come from abroad and the trade deficit widens. If private saving rises with investment unchanged, less is borrowed from abroad and the deficit narrows. If the budget deficit widens with saving and investment unchanged, the trade deficit widens with it. Each is a statement about accounting, not about anyone competing better or worse.
In practice
Worked example: private saving five hundred, investment five hundred, and the government running a deficit of two hundred. The trade balance is minus two hundred. Now the government halves its deficit to one hundred with nothing else changing, and the trade deficit halves to one hundred too. To close the trade deficit entirely while the budget deficit stays at two hundred, private saving would have to reach seven hundred.
Where people slip
The identity holds always, so it never says which term caused which. It says only that the four move together, and that a policy aimed at one of them has to show up somewhere in the other three.
Your place on the trail
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