9. Saving and Investment in Closed and Open Economies

Question 1

What is the relationship between saving and wealth?

Answer 1

National wealth is a country’s holdings of assets minus its liabilities
–> A country with a high saving rate will accumulate national wealth over time

Question 2

What is the definition of wealth?

Answer 2

“A person’s Wealth is the amount of her holding of assets (e.g., stocks, houses) minus her liabilities (e.g., mortgages, loans)”

Question 3

What is the equation for “private disposable income”?

Answer 3

where:

Y = GDP
T = net taxes (i.e., taxes – government transfers – interest payments on debt)

Question 4

What is the equation for “private saving”?

Answer 4

where:
c = consumption expenditure

(basically private disposable income minus consumption)

Question 5

How do we calculate the “private saving rate”?

Answer 5

Sd / Yd

(divide private saving by private disposable income)

Question 6

What do government purchases consist of?

Answer 6

Government investment (Ig)
+
Government consumption (Cg)

Question 7

What is the equation for “government saving”?

Answer 7

Budget surplus: When T > G
Budget deficit: When T < G

Question 8

What is “National saving”?

Answer 8

The sum of private saving and government saving

Question 9

How does a government stimulate saving?

Answer 9

– Tax consumption (e.g., value-add tax—tax
paid by a producer on the difference between
what it receives from the sales minus the costs)

– Provide Tax incentives for saving

– Increase return on saving

– Reduce budget deficits

Question 9

What is the “uses-of-saving identity”?

Answer 9

Because Y = C + I + G + NX

Question 10

What is the “National saving rate”?

Answer 10

S / Y

(national saving over total income or GDP)

Question 11

What is important about saving being “I + NX” (the uses-of-saving identity)?

Answer 11

I + NX
–> This shows that whatever a countries has saved is either used domestically as investment, or abroad as a part of net exports

Question 12

What is the “net capital outflow identity”?

Answer 12

Net capital outlow = Trade Balance

Question 13

What is specific about saving and investment in a closed economy?

Answer 13

Saving = Investment

–> The real interest rate keeps the market for saving and investment in equilibrium

Question 14

What is the equation of “consumption expenditure”?

Answer 14

Question 15

What is the relationship between “consumption” and “interest rate”?

Answer 15

Negative relation between consumption and interest rate. If the interest rate is high, you are more willing to put your money in the bank.

Question 16

What is the equation for “desired saving”?

Answer 16

Basically all are fixed, except interest rate (r)

Hence saving is a function of interest rate

Question 17

Show and explain the “saving-investment” diagram:

Answer 17

–> If interest rate is low, than investment is high, whereas saving is low

–> If interest rate is high, than investment is low, whereas saving is high

Question 18

Explain the “investment function”?

Answer 18

As real interest rates fall, households and firms are more likely to make investments, and so the desired level of investment in the economy will rise

Question 19

How will a change in “autonomous expenditure” impact saving?

Answer 19

A rise in autonomous consumption causes saving and investment to fall and the real interest rate to rise in the long run, while a fall in autonomous consumption causes saving and investment to rise and the real interest rate to fall

Question 20

How will a change in “taxes” impact saving? (fiscal policy)

Answer 20

Changes in taxes – A rise in taxes causes saving and investment to rise and the real interest rate to fall in the long run, while a fall in taxes causes saving and investment to fall and the real interest rate to rise

Question 21

How will a change in “government purchases” impact saving? (fiscal policy)

Answer 21

Changes in government purchases – A rise in government spending causes saving and investment to fall and the real interest rate to rise in the long run, while a decline in government spending causes saving and investment to rise and the real interest rate to fall

Question 22

Explain a decline in savings using a diagram

Answer 22

Question 23

Explain an increase in savings using a diagram

Answer 23

Question 24

How will a change in “autonomous investing” impact saving? (fiscal policy)

Answer 24

Changes in causes the investment curve to shift, which leads to a change in equilibrium real interest rate

• An increase in business optimism or a change in the tax code that increases autonomous investment causes saving, investment, and the real interest rate to rise
• When businesses become more pessimistic or the government raises taxes on investment, lowering autonomous investment, the investment curve will shift to the left, and so saving, investment, and the real interest rate will fall