[MUSIC] That's one thing to think about our, you know, have our, use our visual aid of this big open marketplace, and countries buying and selling there. But how can we link this back to our notions about the economy? The notions you maybe learned in the first course in this series. How can we link it back to GDP? And how can we link it back to the elements of GDP that we've studied? Well, we can think of, as you know, GDP, as C + I + G + (X- M). Those are the parts of GDP, consumption, investment, government spending, and exports minus imports. Now, if we divide those up, we could say GDP = C + I + G + (X- M). And we could take C + I + G and call it A, we'd call it absorption. C, I, and G are all domestic spending on GDP. I consume what I've produced, the government buys what I produce or investors buy what I produce. So, C + I + G, let's call it A. This is domestic absorption of our GDP. The part of, if you will, the cake that we baked that we eat domestically, okay? Then X- M is our trade balance. We're going to call that B, okay? That's out of what we produced, out of our GDP, what did we export, and then what did we import as well? So we now have GDP = A + B, right? If we rearrange this we get a very interesting insight. If we take GDP- A = B, in other words, subtracting A from both sides, we get the idea that the trade balance, which is B, is determined by GDP- A. In other words, what I absorb out of what I produce, and that's interesting, isn't it? In other words, if I produced a GDP, say of 10, and I absorb with C + I + G only 8, then GDP- A is going to give me a positive number for B. I'm going to have a trade surplus because I did not absorb everything I produced, GDP- A give me a positive number. If on the other hand, I have a GDP of 10 and then I have C + I + G, which is 12, in other words, I consumed, invested, and the government spent more than I produced, I'll get a negative number for B, and I will have a trade deficit. This is another way of saying the same thing we said in the earlier section. A country's trade deficit, which is the biggest part of the current account, is determined by its spending patterns. And if a country spends more than its GDP on C + I + G, it will have a trade deficit. And if a country spends less than it's GDP on C + I + G, it will have a trade surplus. Now another way we can think about this is to take the current account and contemplate it as sum of the net borrowing in the economy. So we've got three sectors in the economy, the same ones we've been talking about right now, we've got the government, we've got businesses, and then we've got households. Or we could think of them as the public plus a private sector. We could say the public sector's a government. The private sector is businesses and households. So we can think about the borrowing of those two parts of the economy. If we can think of the public sector, they're borrowing will be G- T, government spending minus taxes. So that's the budget deficit or surplus. That's the public net borrowing. Do we, in our government accounts, spend more than we take in in taxes or do we spend less? Then we can take the private sector and we can say, households and businesses, how much is their net borrowing? Well, that's I- S, investment minus savings. Is that positive? Is that negative? So what we do is we can think of the current account as the sum of the country's whole net borrowing. And the way we can represent that is by saying current account = (G- T) + (I -S), okay? (G- T) being the public borrowing. (I- S) being the private borrowing. And here again, we come to the same conclusion. A current account deficit is a result of the savings, or lack of it, of it's public and private sectors, okay? So we're coming to the same conclusion with both of these approaches. A current account deficit or surplus arises from the spending or saving habits, patterns of the domestic economy. [MUSIC]
