4
$\begingroup$

We know the national income identity: $Y = C + I + G + X - IM$.

From many resourses, $I$ refers to domestic investment. For example in this link: https://opentextbc.ca/principlesofeconomics/chapter/23-4-the-national-saving-and-investment-identity/

However, in Mankiw's book, it says that $I= I^d + I^f$, the summation of domestic investment + foreign investment, as shown in enter image description here

And actually in later pages of Mankiw's book, "I" is referred to domestic investment at many places also.

What does "I" accurately refer to?

$\endgroup$
1
$\begingroup$

I see your confusion that could also apply to $C$ and $G$ because Mankiw starts from \begin{equation} Y= C^d+I^d+G^d+X~~~~~ (1) \end{equation}

$C^d$, $I^d$, and $G^d$ have been subjected to the same ``bit of manipulation'', which is to add and substract the foreign part such that we get the same equality (1).

So the idea here is just that $I$, after the manipulation, is essentially equal to $I^d$, the domestic investment, because $I^f$, the foreign portion, has been substracted from $I$ and appears now in import expenditures ($IM$). In other words $I$, after manipulation, is reinterpreted as domestic investment.

\begin{equation} Y= C + I +G +X -IM ~~~~~ (2) \end{equation}

I think it safe to say that calling $I$ domestic investment is here an "abuse of language"!

The most important is that identities (1) or (2) are consistent with the way we calculate GDP using total value added.

| improve this answer | |
$\endgroup$
  • $\begingroup$ Hi emeryville, thank you for the quick answer! I don't understand your idea. Why don't we interpret "I" as the summation of I^d and I^f, which is the summation of domestic and foreign investment? I think it is how it is defined in the picture $\endgroup$ – Johnson Apr 12 at 7:45
  • $\begingroup$ Hi emeryville, sorry that I still don't understand. We should include the foreign portion I^f in I, because only in this way, it could be cancelled by the corresponding portion in IM, right? $\endgroup$ – Johnson Apr 12 at 8:03
  • $\begingroup$ right! but because there is one extra I^f it should be removed somewhere. Recall that your first equation is Y = C^d + I^d + G^d + X, there is no i^f there. $\endgroup$ – emeryville Apr 12 at 8:18
  • $\begingroup$ @Johnson does the new answer make more sense? $\endgroup$ – emeryville Apr 12 at 8:47
  • $\begingroup$ Hi emeryville, thanks for the update! I'm still confused: if we define (C+I+G) as domestic spending on domestic goods and services and (C~+I~+G~) as domestic spending on foreign goods and services, then Y=C+I+G+X−(C~+I~+G~) is not consistent with equation (1). In this notation, equation (1) is Y=C+I+G+X. $\endgroup$ – Johnson Apr 12 at 18:01
0
$\begingroup$

I is not the summation of I domestic and I foreign. Think about what is being calculated. Y is the total income or rather expenditure for ‘a country’. Foreign investment is income going to another country, not income to this country. IM represents imports of goods and services from overseas, it also represents a form of investment overseas in employment operations.

The reason why consumption, gov spending and investment are domestic only is because they together calculate the expenditure/ inflows to this country with export and import being the only external sources of inflow and outflow of cash.

Y=C+G+I+X-IM I believe IM stands for IMports btw not investment X imports

| improve this answer | |
$\endgroup$
  • $\begingroup$ But in the view of income, we should have Y = C^d + G^d + I^d + X, where C^d, G^d and I^d stand for domestic consumption, investment and gov spending on domestic goods and services, and X is the foreign spending on domestic goods and services. Therefore, in order to include IM = C^f + G^f + I^f, we must write Y = C^d + C^f + G^d + G^f + I^d + I^f + X - IM, and thus I = I^d + I^f. $\endgroup$ – Johnson Apr 13 at 19:09
  • $\begingroup$ Your saying foreign consumption shoupd be counted... why? Y is the expenditure of a country. Country pays money on imports gains income when it exports. Think of a cash flow statement in business. $\endgroup$ – JazKaz Apr 13 at 22:24
  • $\begingroup$ Hi JazKaz, I say Y = C^d + G^d + I^d + X from the view of income. C^d, G^d, I^d and X are four income sources. In my notation, C^f, G^f and I^f are domestic spending on foreign goods and services. $\endgroup$ – Johnson Apr 14 at 5:40
  • $\begingroup$ Johnson, still domestic spending on foreign goods and services is imports... you would be double counting $\endgroup$ – JazKaz Apr 14 at 6:08

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.