ECON 104 3/4/25

Relationship Between Investments, Spending, GDP

• The relationship between savings, investment spending, and their effects on GDP will be explored.

• Understanding how this correlation influences our overall economic outlook is crucial.

Key Concepts in Financial Markets

Financial Markets

• Financial markets are the platforms where savers and borrowers interact.

• Four principal types of financial assets: loans, bonds, stocks, bank deposits.

• The role of financial intermediaries is essential in achieving diversification for investors.

Loanable Funds Market

• The market where savers provide funds to borrowers.

• Equilibrium point in this market determines interest rates.

• Interest rates represent the price of lending money.

• The market equilibrium reflects when the quantity of loanable funds supplied equals the quantity demanded.

Saving and Investment Spending Identity

• In a closed economy:

  • GDP = Consumption + Investment + Government Spending

  • It is assumed all income not spent is saved.

  • National Savings = Private Savings + Government Savings

  • Savings must equal investment spending for the economy overall.

Government Role in Savings

• Governments can also save, resulting in budget surpluses or deficits.

• Budget Surplus: Excess tax revenues over government spending; rare in practice.

• Budget Deficits: Government spending exceeding tax revenues; common in modern economies.

Transition to Open Economy

• In reality, no economy is entirely closed; trade (imports/exports) plays a role.

• Foreign savings can finance domestic investment spending, while domestic savings can finance investment abroad.

Net Capital Inflow/Outflow

• Net Capital Inflow: Difference between total funds flowing into a country versus those flowing out.

• Positive net capital inflow indicates excess foreign investment available for domestic use.

Understanding Interest Rates

• Interest rates determine the opportunity cost of borrowing and lending money.

• Lower interest rates generally increase the quantity of funds demanded; higher rates decrease demand.

• The effective interest rate influences decisions about saving and investing.

Financial Market Dynamics

Demand and Supply of Loanable Funds

• Demand Curve: Variables include interest rates, quantity of money demanded increases as interest rates decrease.

• Supply Curve: More quantity is supplied as interest rates increase, as savers seek higher returns.

• Equilibrium Interest Rate: The point where the demand for funds equals the supply of funds.

• Shifts in the curves occur due to changes in economic conditions.

Present Value Concept

• Present value is the current worth of a future sum of money, considering a specific interest rate.

• It helps determine if an investment today is worthwhile compared to potential future returns.

• Example: To determine how much to invest today to yield $1,000 in a year at a 10% interest rate, the present value formula will calculate the required amount.

Conclusion and Future Learning

• This chapter sets the foundation for understanding how savings and investments function within an economy.

• Future classes will delve into more complex topics such as financial markets and the impact of borrowing on economic growth.