1. Since the government has a budget surplus, the government budget term appears with the supply of capital. The following shows the national savings and investment identity for this economy.

   Quantity supplied of financial capitalS + (T – G) =  = Quantity demanded of financial capitalI + (X – M)

   $$\begin{array}{rcl}\text{Quantity supplied of financial capital}& \text{ = }& \text{Quantity demanded of financial capital}\\ \text{S + (T – G)}& \text{ = }& \text{I + (X – M)}\end{array}$$ 

2. Plugging the given values into the identity shown in part (a), we find that (X – M) = 0.
3. Since the government has a budget deficit, the government budget term appears with the demand for capital. You do not know in advance whether the economy has a trade deficit or a trade surplus. But when you see that the quantity demanded of financial capital exceeds the quantity supplied, you know that there must be an additional quantity of financial capital supplied by foreign investors, which means a trade deficit of 2000. This example shows that in this case there is a higher budget deficit, and a higher trade deficit.

   Quantity supplied of financial capitalS + (M – X)4000 + 2000 =  =  = Quantity demanded of financial capitalI + (G – T)5000 + 1000

   $$\begin{array}{rcl}\text{Quantity supplied of financial capital}& \text{ = }& \text{Quantity demanded of financial capital}\\ \text{S + (M – X)}& \text{ = }& \text{I + (G – T)}\\ \text{4000 + 2000}& \text{ = }& \text{5000 + 1000}\end{array}$$ 

The increase in the government budget surplus and the increase in the trade deficit both increased the supply of financial capital. If investment in physical capital remained unchanged, then private savings must go down, and if savings remained unchanged, then investment must go up. In fact, both effects happened; that is, in the late 1990s, in the U.S. economy, savings declined and investment rose.