Lecture Notes on Savings and Investment in Macroeconomics

Introduction to Macroeconomics

Course: Econ 115
Lecture: 5
Instructor: Martin I Santamaria
Institution: Simon Fraser University

Savings & Investment

Types of Individuals in Economy:

  • Lenders (or Savers): Individuals or entities that possess surplus money.

  • Borrowers (or Investors): Individuals or entities that have insufficient funds for their needs.

Interest Rates:

  • Money is a scarce resource with a price, which is the interest rate.

  • The interest rate plays a crucial role in determining how saving and investment occur in the economy.

National and Household Savings

Understanding GDP

  • The overall economy's savings differs from an individual's household savings.

  • Gross Domestic Product (GDP) Definition:

    • GDP represents the total spending on domestically produced final goods and services.

  • Formula for GDP: GDP=C+I+G+(X−M)GDP = C + I + G + (X - M)

    • Where:

    • $C$ = Consumer spending

    • $I$ = Investment spending

    • $G$ = Government purchases of goods and services

    • $X$ = Exports to other countries

    • $M$ = Imports from other countries

  • Closed Economy Implication:

    • In a closed economy, net exports $X - M = 0$, leading to:
      GDP=C+I+GGDP = C + I + G

Income Relationships and Savings

  • Total Income consists of consumption and savings.

  • Key Equations:

    • Total Income = Consumption Spending + Savings

    • Total Income = Consumption Spending + Investment Spending

  • Savings Defined:

    • Savings is often viewed as future consumption or delayed consumption.

  • Thus, we examine the two equations representing income distribution:
    Y=C+SY = C + S
    Y=C+IY = C + I

Savings–Investment Identity

Equal Identity

  • The identity that savings and investment spending must be equal for the economy as a whole:

  • Savings–Investment Spending Identity:

    • S=IS = I

    • This identity emphasizes that total income can be allocated either to consumption or saving, which translates to investment for future productivity.

National Savings Definition

  • National Saving (S):

    • Represents the total income remaining after consumption and government purchases.

    • Equation:
      S=Y−C−GS = Y - C - G

    • Where $Y$ is total income, $C$ is total consumption, and $G$ is total government spending.

Government Influence on Saving

  • Understanding how government actions influence national saving:

    • Let $T$ be taxes collected and $Tr$ be transfer payments.

  • Public Savings Equation:

    • Sp=T−GS_p = T - G

  • Private Savings Equation:

    • Spriv=Y−T−CS_{priv} = Y - T - C

  • Therefore, the national saving becomes: S=S<em>priv+S</em>pS = S<em>{priv} + S</em>p

    • The equations elucidate how public and private savings affect overall national saving.

Government Budgets

Surplus and Deficits

  • Budget Surplus: When tax revenue exceeds government spending:

    • T > G

  • Budget Deficit: When tax revenue falls short of government spending:

    • T < G

    • Government borrowing arises from budget deficits, accumulating to government debt over time.

Open vs Closed Economies

Open Economy Concepts

  • An open economy allows goods and money to flow across borders.

  • Net Foreign Investment (NFI):

    • Represents the difference between funds flowing into a country from foreign investments and funds flowing out.

    • Definition:
      NFI=Outflows−InflowsNFI = Outflows - Inflows

  • For example, in 2019, Canada experienced a net foreign investment of -$38.9 billion, indicating greater foreign investment in Canada than Canadian investments abroad.

Imports and Exports

  • If a country imports more than it exports, it must borrow the difference.

  • Net Foreign Investment Equation:
    NFI=X−MNFI = X - M

  • Savings Relation:

    • Further rearrangements lead to a new representation of national savings as incorporating net foreign investments:
      S=I+NFIS = I + NFI

Balance of Payments

Overview of Balance of Payments

  • The balance of payments represents a systematic record of all economic transactions between a country and the rest of the world.

  • It includes the current account and the financial account:

Current and Financial Accounts

  • Current Account:

    • Comprises transactions related to goods and services, income, and current transfers.

    • Trade Balance:

    • Difference between exports and imports of physical goods exclusively.

  • Financial Account:

    • Examines transactions related to financial assets.

    • It considers net sales of assets to foreigners versus purchases of assets from foreigners.

Revenue Equality Principle

  • The current and financial accounts must balance, or equivalently:
    Current Account+Financial Account=0Current\, Account + Financial \ Account = 0

Deficits and Surpluses

  • Current Account Deficit (CAD): More payments to foreigners for goods and services than the amount received from them.

    • For Canada in 2019, the CAD stood at –$47.1 billion.

  • Financial Account Surplus: Surplus indicates that the value of assets sold to foreigners exceeded the value of assets purchased from them.

Determinants of Capital Flows

Financial Account Insights

  • A country's financial account reflects its net sales of assets.

  • Capital Inflows: - Foreign savings used to finance domestic investment spending.

  • Capital Outflows: - Domestic savings employed to finance investment spending in other countries.

Investor Behavior

  • Investors often diversify their capital by spreading investments across different countries.

    • Portfolio Investment: Invest in foreign stocks/bonds for diversification.

    • Foreign Direct Investment: Corporations invest abroad for strategic business interests.

Market for Loans

Loanable Funds Market Dynamics

  • Description: The hypothetical market represents the interaction between savers and borrowers seeking funds.

  • Interest Rate Concept: The price of loans is represented by the nominal interest rate, which may vary based on loan conditions and risk parameters.

The Present Value Calculation

  • Investment Expectation: An investment is feasible only if future returns exceed present costs.

  • Present Value (PV) Formula:
    PV=Future Value(1+r)nPV = \frac{Future\, Value}{(1 + r)^n}

  • Example of Present Value calculation method concerning interest rates and future financial needs detailed in academic context.

Demand and Supply Curves

  • Demand curve for loanable funds is downward sloping - lower interest rates demand more loanable funds.

  • Supply curve for loanable funds is upward sloping - higher interest rates incentivize saving.

Market Equilibrium

  • Equilibrium Interest Rate: The interest rate where the quantity of loanable funds demanded matches the quantity supplied.

  • Conditions for efficient market outcomes confirmed through equilibrium intersection points.

External Factors Influencing Rates

  • Factors causing shifts in demand and supply, such as government policy changes, investment opportunities, and inflation expectations could modify the loanable funds market dynamics significantly.