Social Sciences and History / Unit 15 SSH 1403 worked example, 60 to 90 seconds
The Saving and Investment Identity: Working It
The idea
The exam gives a country's saving, investment, budget balance and trade balance and asks which must follow, and the anchor's identity answers: the financial capital supplied from all sources equals the financial capital demanded from all sources. With S private saving, T taxes, G government spending, M imports, X exports and I investment, for an economy with a current account deficit and a budget deficit, S plus M minus X equals I plus G minus T: private saving plus the capital inflow the trade deficit brings supplies what investment and the government's borrowing demand. Rearranged, a larger budget deficit, with saving and investment unchanged, must be matched by a larger trade deficit; a recession raises the trade balance, a boom lowers it.
In practice
Given "saving one hundred, investment one hundred twenty, a budget deficit of thirty", the trade deficit must be fifty, since one hundred plus fifty equals one hundred twenty plus thirty. Given "the budget moves to balance with nothing else changing", the trade deficit falls to twenty. Given "a boom", imports rise and the trade balance falls. Ask which term is missing and solve the identity for it.
Where people slip
The trap is reading the identity as a theory; it is an accounting truth, so it says what must balance, not what caused it. The second trap is the sign of M minus X, which is positive in a deficit.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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