The National Income equation Y=C + I + G

It is important by stating what Gross Domestic Product (GDP) means. GDP refers to the total income in an economy and the total expenditure on the economy’s output of goods and services. GDP (denoted as Y) is divided into four components of expenditure: consumption (C), investment (I), government purchases (G), and when we add the net exports (NX) which is very important, we have Y = C + I + G + NX This equation is an identity because every Naira (National currency of Nigeria) of expenditure that shows up on the left-hand side also shows up in one of the four components on the right-hand side. Because of the way, each of these variables is defined and measured, this equation must always hold. A closed economy is an economy that does not interact with other economies.Y = C + I + GThat was exactly what you statedIn particular, a closed economy does not engage in international trade in goods and services, nor does it engage in international borrowing and lending. Of course, actual economies are open economies, i.e. they interact with other economies around the world. Nonetheless, assuming a closed economy is a useful simplification by which we can learn some lessons that apply to all economies and for the exact purpose of your question. Moreover, this assumption applies perfectly to the world economy. Because a closed economy does not engage in international trade, imports and exports are exactly zero. Therefore, net exports (NX) are also zero. In this case, we can write Y = C + I + G This equation states that GDP is the sum of consumption, investment, and government purchases. Each unit of output sold in a closed economy is consumed, invested, or bought by the government. To see what this identity can tell us about financial markets, subtract C and G from both sides of this equation. We obtain Y C G = I The left-hand side of this equation (Y C G) is the total income in the economy that remains after paying for consumption and government purchases: This amount is called National Saving, or just saving, and is denoted as S. Substituting S for Y C G, we can write the last equation as S = I This equation states that saving equals investment. To understand the meaning of national saving, it is helpful to manipulate the definition a bit more. Let T denote the amount that the government collects from households in taxes minus the amount it pays back to households in the form of transfer payments. We can then write national saving in either of two ways: S = Y C G Or S = (Y T C) + (T G) These equations are the same, because the two Ts in the second equation cancel each other, but each reveals a different way of thinking about national saving. In particular, the second equation separates national saving into two pieces: private saving (Y T C) and public saving (T G). Consider each of these two pieces: Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. In particular, because households receive income of Y, pay taxes of T, and spend C on consumption, private saving is Y T - C. Public saving is the amount of tax revenue and spends G on goods and services. If T exceeds G, the government runs a budget surplus because it receives more money than it spends. This surplus of T G represents public saving. If the government spends more than it receives in tax revenue, then G is larger than T. In this case, the government runs a budget deficit, and public saving T G is a negative number. These two equation static model with government expenditures and taxes, has variables: C consumption I investment G government expenditures T taxes Y real GNP; witha,b known constants addedIn this model the level of government expenditures, taxes and investment are fixed. The purpose of this model is to study the fiscal policy options of government, that is the effect of G and T on Y and C. This model is the simplest model of this type. Equations: Y = C + I + G ________ (1) C = a + b(Y - T) ______ (2) This model is slightly more realistic than the two equation model in that it contains a government and consumption is based on disposable income. As models get bigger they attempt to capture more of the behavior of the economy. These simple models are solely for instructional purposes. Substituting 2 into 1 , we haveY = a + b(Y -T) + I + G Y = a + bY - bT + I + G Subtract bY from both sides Y - bY = a + I - bT + G Collect terms (1 - b)Y = 1(a + I - bT + G) Y = k(a + I - bT + G) where k = 1/(1 - b) The solution to this model has the same form as the simple two equation model. In policy work the analyst is interested in considering the impact of a change in G of T. Using the same type of algebra as for the simple two equation model we can obtain the following equations. Þ(Y) = kÞ(G) Þ(Y) = kÞ(I) Þ(Y) = kÞ(a) Þ(Y) = -kbÞ(T) The first shows the impact of a change in government expenditures, the second the impact of private investment, the third shows a shift in consumer confidence, and the last indicates a shift in tax policy. The government has direct control over G and T and indirect influence over a and I through incentives and its policies. Now consider how these accounting identities are related to financial markets. The equation S = I reveal an important fact: For the economy as a whole, saving must be equal to investment. Yet this fact raises some important questions: What mechanisms lie behind this identity? What coordinates those people who are deciding how much to save and those people who are deciding how much to invest The answer is: the financial system. The bond market, the stock market, banks, mutual funds, and other financial markets and intermediaries stand between the two sides of the S = I equation. They take in the nations saving and direct it to the nations investment. The terms saving & investment can sometimes be confusing. Most people use these terms casually and sometimes interchangeably. By contrast, the macroeconomists who put together the national income accounts use these terms carefully and distinctly. Consider an example. Suppose that THLIZA earns more than he spends and deposits his unspent income in a United Bank for Africa or uses it to buy a bond or some stock from a corporation say, Dangote Sugar Refinery. Because THLIZA’s income exceeds his consumption, he adds to the nations saving. THLIZA might think of himself as investing his money, but a macroeconomist would call THLIZA’s act saving rather than investment. In the language of macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings. When Austin borrows from the bank to build himself a new house, he adds to the nation’s investment. Similarly, when the APT Corporation sells some stock and uses the proceeds to build a new factory, it also adds to the nation’s investment. Although the accounting identity S = I shows that saving & investment are equal for the economy as a whole, this does not have to be true for every individual household or firm. THLIZA’s saving can be greater than his investment, and he can deposit the excess in a bank. Austin’s saving can be less than his investment, and he can borrow the shortfall from a bank. Banks and other financial institutions make these individual differences between saving & investment possible by allowing one persons saving to finance another persons investment.