Chapter 13: Savings, Investment, and the Financial System

Importance of Savings and Investment

• Key to Increasing Living Standards: Economists emphasize that savings and investment are crucial for improving living standards.
• Definitions:
  • Savings: The act of setting aside purchasing power for future use.
  • Investment: Refers to purchasing new capital (such as equipment or buildings) or borrowing to finance those purchases.

National Income Accounting

• National Income Account Identity: The identity is expressed as: $Y = C + I + G + NX$
  • Where:
  • $Y$ = National Income
  • $C$ = Consumption
  • $I$ = Investment
  • $G$ = Government Spending
  • $NX$ = Net Exports
• Purpose: This formula allows economists to understand the relationships between different macroeconomic indicators.
• Closed Economy: In a closed economy (no trade), the equation simplifies to: $Y = C + I + G$
  • In this case, national saving is equivalent to investment:
    $S = I$

Types of Saving

1. Private Saving:
   • Defined as:
     $ext{Private Saving} = Y - T - C$
   • Where $T$ is taxes. It's the leftover income households have after consumption and taxes.
2. Public Saving:
   • Calculated as:
     $ext{Public Saving} = T - G$
   • This represents the leftover tax revenue after government spending.

Example 1: Calculating Public Saving

• Scenario: Last quarter, in a closed economy:
  • GDP: 150,000
  • Expenditures on capital goods: 19,000
  • Inventory Increase: 1,000
  • New Home Construction: 8,000
  • Consumption: 85,000
  • Taxes: 32,000

Calculating Public Saving:

1. Investment Calculation:
   $I = 19,000 + 1,000 + 8,000 = 28,000$
2. Finding Government Spending (G):
   • From the identity:
     $G = Y - C - I$
   • Substitute values:
     $G = 150,000 - 85,000 - 28,000 = 37,000$
3. Public Saving Calculation:
   $ext{Public Saving} = T - G = 32,000 - 37,000 = -5,000$

Example 2: Investment, Public Saving, and National Saving

• Scenario: In a small closed economy, where:
  • Investment: $20 billion
  • Private Saving: $15 billion
• Determine Public Saving and National Saving:

1. Public Saving Calculation: $ext{Public Saving} = T - G$
   • Rearranging Income Identity:
     $Y = C + I + G$
   • With private saving: $T - C = 15$
   • Hence, $T - G + T - C = 20$
   • Results in:
     $G = 20 - 15 = 5$

Budget Balance of the Government

• Government Budget: Refers to the total amount of money allocated for spending within a year.

• Budget Balance: Determined by whether government spending exceeds tax revenue.

  • Budget Deficit: When spending exceeds income (tax revenue).
  • Budget Surplus: When income exceeds spending.

• Public Saving Formula:
  $ext{Public Saving} = T - G$

  • This highlights the relationship between tax revenue and government spending in determining public savings.