Understanding Sectoral Analysis
08 August 2017 | Pago Pago, American Samoa
We all know that GDP (Gross Domestic Product) is the value of all goods and services sold within a country during one year. GDP is a flow variable. Flows come from from the national income accounting relationship:
1) Y = C + I + G + (X – M)
where Y is GDP (expenditure), G is government spending, X is exports and M is imports (so X – M = net exports), C, consumption and I investment.
But national income accounting shows households can use their total income for consumption, savings and to pay taxes:
2) Y = C + S + T
The assumption then becomes everything feeds through to households so corporations are just transparent.
You than then make the two equations Y is equal to, equal each other
3) C + S + T = Y = C + I + G + (X – M)
Subtracting C from both sides and you get:
4) S + T = I + G + (X – M)
Rearranging, this becomes the sector balance accounting equation
5) (S – I) = (G – T) + (X – M)
The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit plus net exports. Net exports represent the net savings of non-residents.
This is alway true. It is an accounting identity.
For example, if Savings increase and Investment and net exports remain unchanged, then the deficit (G - T) has to increase. Who'da thought? Now the next question is economically why.