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Lecture 8 - Lecture 8 Finishing Up the Spending Allocation...

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Lecture 8: Finishing Up the Spending Allocation Model
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We can also show that the determination of R in our spending allocation model is equivalent to determining R in the framework of saving and investment. This is of some interest because saving represents the resources available for investment. Also, the resulting graphs look a lot like supply and demand curves, bringing us back to earlier lectures. So it demonstrates the factors that determine R in another—perhaps more intuitive—way.
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Firms Rest of the World Gov’t Consume rs Financial Market Saving C G I X The “Circular Flow” and Saving Surplus Deficit Trade Surplus Trade Deficit
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To see the relationship between the national saving rate and the interest rate, we can rewrite the spending equation . . . . . . Y = C + I + G + X Y – C = I + G + X (Y – C – T) + (T – G) = I + X Private + Gov’t = I + X Saving Saving National Saving (S) = I + X and dividing by GDP in the long run S/Y = I/Y + X/Y This is the same as saying C/Y + I/Y + X/Y = 1 – G/Y You can also determine the equilibrium real interest rate using the saving rate relationship.
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S/Y is positively related to R Easiest way to see this is to note that S/Y = 1 – C/Y – G/Y When R increases (decreases), G/Y is unchanged and C/Y falls (rises).
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I/Y + X/Y is negatively related to R I/Y X/Y I/Y + X/Y
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Something else to note: I/Y + X/Y is the same as investment financed by national saving X = Exports – Imports When Imports > Exports, we’re running a trade deficit. A trade deficit means that we’re spending more than we’re producing. The way we spend more than we produce (or more than our income— remember production equals income) is by using foreign saving. So negative X is  like positive foreign saving. 
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