Chapter 19 - Saving, capital formation & financial markets

Saving and wealth

• Saving: current income minus spending on current needs.

• Saving rate: saving divided by income.

• Wealth: value of assets minus liabilities.

• Assets: anything of value that one owns.

• Liabilities: debts one owes.

• Balance sheet: list of an economic unit's assets and liabilities on a specific a date.

• Flow: measure that is defined per unit of time.

• Stock: measure that is defined at a point in time.

• Capital gains: increases in the value of existing assets.

• Capital losses: decreases in the value of existing assets.

National saving and its components

• National saving: saving of the entire economy, equal to GDP less consumption expenditures and government purchases of goods and services, or Y - C - G.

• Transfer payments: payments the government makes to the public for which it receives no current goods/services in return.

• Private saving: saving of the private sector of the economy is equal to the after-tax income of the private sector minus consumption expenditures (Y - T - C)

  • It can be further broken down into household saving and business saving.

• Public saving: saving of the government sector is equal to net tax payments minus government purchases (T - G).

• Government budget surplus: excess of government tax collections over government spending (T - G)

  • It equals public saving.

• Government budget deficit: excess of government spending over tax collections (G - T).

Why do people save?

• Life-cycle saving: saving to meet long-term objectives such as retirement, college attendance, or the purchase of a home.

• Precautionary saving: saving for protection against unexpected setbacks such as the loss of a job or a medical emergency.

• Bequest saving: saving done for the purpose of leaving an inheritance.

Investment and capital formation

• Any of the following factors will increase the willingness of firms to invest in new capital:
  • Decline in the price of new capital goods
  • Decline in the real interest rate
  • Technological improvement that raises the marginal product of capital
  • Lower taxes on the revenues generated by capital
  • Higher relative price for the firm's output

Bonds, stocks and the allocation of savings

• Bond: legal promise to repay a debt, usually including both the principal amount and regular interest, or coupon, payments.

• Principal amount: amount originally lent.

• Maturation date: date at which the principal of a bond will be repaid.

• Coupon payments: regular interest payments made to the bondholder.

• Coupon rate: interest rate promised when a bond is issued; the annual coupon payments are equal to the coupon rate times the principal amount of the bond.

• Stock (or equity): claim to partial ownership of a firm.

• Dividend: regular payment received by stockholders for each share that they own.

• Risk premium: rate of return that financial investors require to hold risky assets minus the rate of return on safe assets.

• Diversification: practice of spreading one's wealth over a variety of different financial investments to reduce overall risk.

• Mutual fund: financial intermediary that sells shares in itself to the public and then uses the funds raised to buy a wide variety of financial assets.

Saving, investment and financial markets

• Any of the following factors will shift the demand for savings (I) to the right:

  • Decline in the price of new capital goods
  • Technological improvement that raises the marginal product of capital
  • lower taxes on the revenues generated by capital
  • Higher relative price for the firm's output
  • Supply of savings will shift right if national saving, private and/or public saving, is increased.