International flow of capital, trade and service

Consider an eqn, that whatever income is earned is consumed/ spent i.e. Total Income = Total spending If the GDP has to be defined in such cases, whatever is produced is consumed, i.e the consumer has to pay for the purchase GDP = Total Income = Total spending E.g. you purchase a car worth 7,00,000, this Rs 7 lac that you have spent would be used by the company to pay salaries, interest, vendor payment . The balance would be used by the owners or Co as profit. Now if these people earn income, what do they do of that income? Total income = Consumption + Savings -------------(1) [Saving = postponement of Current consumption] If the pvt. Sector / Company earn income, how do they spend? Total Spending = Consumption + Investment s -------------(2) [Investment = investment in physical assets] From eqn 1 and 2 Ni = C + S -----------------------------------(1) Ns = C + I ---------------------------------- -(2) Ni Ns = S I ------------------------------(3) Condition [1] If Ni > Ns = S > I ---------------------------(4) i.e. S > I = excess funds available in the nation i.e. S > I = excess capital / surplus capital Note you cannot invest this excess capital in domestic market, because you have already exhausted the investment limit. It means no further domestic investment is possible. The surplus capital has to go out of India i.e. Surplus Saving = [domestic saving] + [net foreign investment] ------(5) [net foreign investment] = [public + pvt capital] + [Net capital transfer] ---------------------(6)

Consider GDP and denoted by Y Y = Consumption + Investment +Govt. spending Plz Note Export not considered as of now. i.e Y = C + I + Gs i.e. Y C Gs = I i.e. saving = investment Since we have a govt, the govt will levy tax. i.e. Pvt sector would be taxed and the tax proceeds would be used by he govt for national spending (Y C T )+ (T-Gs) = I ---------------------(7) If T = G, it means T-G = 0, all invest is done by Pvt sector If T > G, Govt has a Surplus budget, If T < G, Govt has a Deficit budget

Consider if T > G, Govt has a Surplus budget, (Y C T )+ (T > Gs) = I ---------------------(8) Public and pvt capital outflow = financial a/c deficit Consider if T < G, Govt has a Deficit budget, (Y C T )+ (T < Gs) = I ---------------------(9) Public and pvt capital inflow = financial a/c Surplus Conclusion for inflow /outflow of funds National saving (deficit) = Surplus in financial a/c National saving (Surplus) = Deficit in financial a/c

Let us consider goods/services N products = Total goods / services produced Out of the total goods produced, some would be consumed in India or domestic level i.e. National product - Domestic consumption = Balance available for export But if Domestic consumption National product = Balance available for import

Np Dc = Export Import Ni Ne = Export Import

Saving Investment = Export Imports If Saving > Investment = Export and CA surplus e.g. japan If Saving < Investment = Import and CA deficit e.g. US

Equilibrium and Disequilibrium, Consider eqn (8) (Y C T)+ (T - Gs) = I Pvt saving + Public savings = total Savings i.e Total Saving = Investment I.e. if saving are generated / money is available as funds for borrowers i.e. loanable funds Loanable RoI = Real Interest rates Real interest rate = Nominal interest + Inflation Consider for given level of demand for funds, we get certain supply of funds. At point A, supply curve intersects the demand curve. In case if there is economic expansion the demand for funds shifts, as a result Increase of demand leads to more profit Supplier of funds expect higher return

The 2nd reason for shift in demand curve is due to govt intervention If govt. is running a deficit budget i.e. (T<G) Govt. must borrow from the market by issuing bonds, so if govt borrows, the demand curve shift I.e. we get D2 curve (Pvt + public borrowing) i.e. Q2 Q1 = B A (B A funds demanded) Because of govt. borrowing, pvt sector does not want to invest at Q1, but would invest at Q3. Reduction of pvt investment due to govt. borrowing is called crowding out and the reverse is crowding in.