Chapter 2C

Matching up savings and investment spending

In the modern economy, individuals and firms often pay for private investment spending by creating physical capital with other people’s money.

• S ≡ I : savings + investment spending are always equal for the aggregate economy;

  • in a closed economy, there are no exports and imports:

    
    

    Total income = Total spending:
    GNP = Y = C + I + G

    
    Income can either be spent on (C) + (G) or saved (S):
    GNP = Y = C + G + S

Private and Government Saving

Private saving is the part of disposable income (national income Y — taxes T) that is saved rather than consumed:

Government saving is net tax revenue T — government spending G:

• Private and govt saving add up to national saving.

Matching savings and investment in a closed economy

Saving = Investment in Open Economies

Two important distinctions must be made about open economies:

1. Small open economy: too small to affect interest rate rʷ

2. Large open economy: affects interest rates rʷ

   where rʷ is the world interest rate in the international capital market.

Only consider small open economies, unless otherwise stated.

Small open economy

Key takeaway:

• By knowing the interest rate and the S,I curves, we know whether the country is;

  • a net borrower or net lender,

  • S*, I*, NFL, CA, and KFA