Foreign financial borrowing pays for deficit with rest of the world. These financial flows are sources of funds for the firm to pay for investmentin new capital. How Investment is FinancedInvestment adds to the stock of capital. Investment is one of the determinants of the rate at which capital grows. There are three sources of investment. (1) Private savings, (2) Government budget surplus (3) Borrowing from the rest of the world.Household income is consumed, paid as taxes or saved. That is Y = C + S+ T. We also know from the expenditure approach that Y = C + I+G + X – M. Using the two equation, we get: I + G + X – M = S + T. Solving for investment, we get: I = S + (T - G) + ( M – X). T – G is defined as government surplus, or public savings. M – Xis defined as borrowing from the rest of the world. Sis defined as private savings.If taxes exceed government purchases, the government has budget surplus equal to T – G, and this surplus contributes towards paying for investment. If taxes are less than government purchases, the government has a budget deficit equal to T - G which is
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