Suppose that there are only two economies in the world, Green and Red. All numbe

Question

Suppose that there are only two economies in the world, Green and Red. All numbers below are in billions of dollars. Assume that Green’s National Saving is 4000 while Red’s National Saving is 4800. Investment in Green is 3600. What would happen to Green’s current account if Green’s investment were to increase to 4000, while national saving in Green remained the same as before (4000)? Assuming that national saving were to remained unchanged in Red as well (at 4800), how would investment have to adjust in Red following Green’s investment increase from 3600 to 4000 (still assuming that national saving is 4000 in Green)?

Explanation / Answer

Current account is the balance between nation’s savings and its investment. It is the sum of the balance of trade and services, net income from abroad and net current transfers. When investment increase in Green, its current account is balance as investment would equal national savings. Red will have to maintain its current account balance by making its savings equal to investment.

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