ppt_ch10

SAVINGS AND INVESTMENT

Chapter 10 Overview

This chapter focuses on the essential concepts of savings and investment in the context of economics, providing a foundational understanding of how these concepts drive economic growth and development.

Defining Investment

Investment refers to the allocation of resources towards the creation of new capital assets that enhance the economy's productive capacity. This includes not only traditional forms of investment but also emerging sectors that contribute to economic dynamism. Different forms of investment include:

• Buying stocks: Purchasing shares of companies, which can provide dividends and capital gains as the company grows.

• Purchasing gold: Investing in precious metals, often sought as a hedge against inflation and economic uncertainty.

• Acquiring land: Investing in real estate, which can appreciate in value and generate rental income.

• Depositing money in the bank: Utilizing savings accounts and fixed deposits to earn interest, thus contributing to liquidity in the economy.

Confusion often arises between saving and investing, as both involve setting aside resources; however, saving is typically reserved for short-term needs while investing is aimed at future growth.

Areas Where Investment Occurs

Investment occurs in various sectors, including but not limited to:

• New software: Crucial for improving productivity and efficiency in numerous businesses.

• Equipment: Investments in machinery and technology to enhance operational capacities.

• Structures: Construction of buildings and facilities, which contribute to urban development and infrastructure.

• New housing: Addressing housing shortages and contributing to economic stability.

• Intellectual property: Investing in patents, trademarks, and copyrights that can generate future revenue streams.

• Accumulation of inventories: Businesses invest in goods that can be sold to meet consumer demand.

Matching Savings and Investment Spending

The Savings–Investment Spending Identity is a central concept in economics, stating that, at a macroeconomic level, total savings must equal total investment spending. This identity reveals the crucial interplay between saving and investment in supporting economic stability and growth.

Government Savings

The formula for public savings is defined as:Spublic = T − TR − G Where:

• T = Tax revenue obtained by the government

• TR = Transfer payments, such as social welfare or unemployment benefits

• G = Government spending on goods and servicesKey considerations include the budget balance, which indicates whether the government is running a surplus or deficit, affecting overall economic health.

Private Savings

The formula for private savings can be expressed as:Sprivate = GDP + TR − T − CWhere:

• GDP = Gross Domestic Product, a measure of economic output

• C = Total consumption expenditures by households

• NTR = Net tax revenue, which impacts disposable income and subsequent saving behavior.

National Saving

The national savings formula is represented as:Snational = Sprivate + SpublicThis illustrates the total amount of savings generated within the economy, which is critical for funding future investments.

Saving and Investment in a Closed Economy

In the context of a closed economy, the GDP identity can be expressed as:Y = C + I + GRearranging this yields a formula for investment:I = Y - C - GWhere investment (I) can be equated to the sum of private and public savings. Thus, the Savings–Investment Spending Identity can be expressed as:

• Sprivate = GDP + TR − T − C

• Spublic = T − TR − G

• Snational = Sprivate + Spublic = (GDP + TR − T − C) + (T − TR − G)This leads to the conclusion that: Snational = I in a closed economy, emphasizing the importance of both types of savings in sustaining investment levels.

Saving and Investment in an Open Economy

In an open economy, the GDP formula expands to include international trade: Y = C + I + G + EX − IMWhere:

• EX = Exports of goods and services

• IM = Imports of goods and servicesRearranging gives us:I = Y - C - G - EX + IMThis allows for the inclusion of net foreign investment, which is significant for understanding how economies interact on a global scale.

The Savings–Investment Spending Identity in an Open Economy

Net Foreign Investment (NFI) is expressed as: NFI = X - IMWhere X represents exports and IM represents imports. This sector establishes a distinction between net lender and net borrower countries, essential for understanding a country's position in global capital flows.

NFI and S & I Relationship

The relationship explored shows:

• When Snational > I, the country acts as a net lender (NFI > 0).

• When Snational < I, the country is a net borrower (NFI < 0), impacting its foreign liability and investment capability.

Examples in Closed and Open Economies

Closed Economy Example:Given:

• GDP = 700

• C = 550

• G = 100

• NTR = 125Calculated Investment: I = 50 billionPrivate savings: Spvt = 25 billion, public savings: Spub = 25 billion.

Open Economy Example:Given:

• GDP = 700

• C = 550

• G = 100

• NTR = 125

• EX = 230, IM = 200Calculated Investment: I = 20 billionNFI: 30 billion, overall saving: 20 billion.

Different Kinds of Capital

1. Physical Capital: Refers to tangible assets such as manufactured resources, buildings, and machinery that are critical for production.

2. Human Capital: Focuses on the skills and education that enhance the labor force's productivity, influencing economic growth positively.

3. Financial Capital: Represents the funds available from savings that can be used for further investment in physical and human capital.

The Domestic Market for Loanable Funds

This market refers to a theoretical model of borrowing and lending funds where the interest rate acts as the equilibrium price.

• The interest rate is the price charged by lenders for the utilization of borrowed savings, directly affecting the level of investment in the economy.

Rate of Return on a Project

This is expressed as the profit generated from an investment project, represented as a percentage of the initial cost, indicating its profitability and attractiveness.

Supply and Demand Curves for Loanable Funds

These curves visually depict the demand for loanable funds, illustrating how interest rates are influenced by the interplay between savers and borrowers in the economy.

Shifts in Demand and Supply for Loanable Funds

Changes in the demand and supply curves can arise due to various factors:

• Changes in business opportunities due to technological advancements and market expansion.

• Government policies affecting investment, such as tax incentives or regulations that influence savings behavior.

• Private savings behavior, which can change in response to economic conditions and consumer confidence.

Crowding Out in the Loanable Funds Market

Crowding out occurs when government borrowing drives up interest rates, making it more expensive for private investors to borrow, consequently reducing private investment spending which can hamper economic growth.

Interest Rates and Their Influences

Interest rates can fluctuate based on shifts in the supply and demand for loanable funds, influenced by:

• Government policy changes (e.g., fiscal or monetary policy changes).

• Technological innovations that can alter the economic landscape.

Inflation and Interest Rates

Changing expectations regarding future inflation can significantly influence current interest rates, highlighting the importance of predictive economic models.

The Fisher Effect

This principle outlines the relationship between inflation and nominal interest rates, indicating that higher anticipated inflation leads to higher nominal rates while expected real rates remain unchanged.

Global Loanable Funds Market

The synchronization of international capital flows leads to the equalization of interest rates across different nations, allowing capital to flow to where it can achieve the highest returns, demonstrating the interconnected nature of the global economy.