Savings and Investment Flashcards
What is the savings-investment identity?
-The savings-investment identity shows that investment must equal to savings for the economy as a whole.
-Investment=Savings
What does investment and savings represent?
-Investment represents the demand for funds.
-Savings represents the supply for funds.
What two categories does an economy divide it’s total income into?
-Spending and savings are the two categories
-National savings is the amount of output not devoted to current consumption.
What two sources do national savings come from? What are their formulas?
1) Private savings. Savings done by households.
Private Savings=Output(Y)-Taxes(T)+Transfers(TR)-Consumption(C).
Private Savings=Y-T+TR-C
Disposable Income-Consumption.
2) Public savings. Savings done by all levels of government.
Public Savings=Taxes(T)-Transfers(TR)-Government spending on final goods&services(G)=Government budget balance (GBB)
Public Savings=T-TR-G=GBB
Total National Savings: Y-C-G
When is there a budget surplus? When is there a balanced budget? When is there a budget deficit?
-If (T-TR-G)>0, the Public Savings>0, we have a budget surplus. Savings>Spending.
-If (T-TR-G)=0, then Public Savings=0, we have a balanced budget. Savings=Spending
-If (T-TR-G)<0, then we have a budget deficit. Savings<Spending
What does an open economy involve?
1) Capital outflows. Occurs when we purchase foreign assets or when we invest in foreign companies.
2) Capital inflows. Occurs when foreigners purchase domestic assets or when foreigners invest in our economies.
What is net foreign investment (NFI)?
-Net foreign investment(NFI)=Purchases of foreign assets from foreigners-sales of domestic assets to foreigners
-Net foreign investment must equal net exports.
-NFI=X-IM=NX
-NFI measures the international flows of goods and services.
When a country runs a trade surplus, what does that mean?
-It means that they receive more export revenues, than they pay for imports.
-Then they can use excess export revenues earned to buy foreign assets.
What two ways can an open economy allocate it’s savings?
1) Accumulate physical capital-undertake domestic investment(I)
2) Acquire foreign assets-undertake foreign investment (NFI)
What is the fomrula for national savings?
National Savings=I+NFI
National Savings=Investment+Net Foreign Investment
Where does the demand for loanable funds come from? What are the assumptions?
-The demand for loanable funds comes from investment, because those who have investment opportunities (mainly households and firms) need to borrow funds to finance their investment.
-We assume that the returns on investment projects are given or known. Only investment projects with positivie net present value are undertaken. The interest rate represents the opportunity cost of investment.
What is the formula for Net Present Value?
NPV of an investment=Present value of the return on this investment-Present cost
What is the formula for present value?
PV=Payment at time t/(1+i)^n.
Where i=interest rate and n=#of years
When interest rate rises, what happens to investment?
There are less profitable investment opportunities.
Which factors shift the demand for loanable funds?
-Any factors that affect investment other than interest rate will shift the demand curve for loanable funds.
-Changes in perceived future payoffs of investment change demand. For example, if technological innovation is antipated to increase total factor productivity, they will invest early to prepare for that.
-Changes in government policies can affect investment. Suppose the government provides a tax credit on investment, that lowers the cost of investment, which encourages firms to invest
Where does the supply of loanable funds come from?
-The supply of funds comes from national savings.
-There is a positive relationship between interest rate and supply of funds.
-When interest rates rise, today’s consumption becomes more expensive while the returns on savings rise.
Aside from interest rate which factors shift the supply curve of loanable funds?
1) Changes in private savings behaviour such as changes in households’ wealth, changes in preference between current and future consumption. Suppose households find the value of their houses rise, so they spend more.
2) Changes in government budget balance. Remember public saving is the government budget balance. When Public saving decrease, national savings decrease because National Savings=Private Savings+Public Savings.
When expected inflation rate is expected to rise, what happens to supply and demand in the loanable funds market?
-Demand shifts right. People want money
-Supply shifts left.
When budget deficit goes to zero, how does that affect public saving? How does that affect supply of loanable funds?
-When the budget deficit goes to zero, that means that public savings goes up.
-That’s because budge balance=public saving
-National Saving will go up, and that will mean an increase in the supply of loanable funds.
-The excess supply of loanable funds will apply downward pressure on the interest rate.
When interest rates drop, how is saving effected?
-Purchasing goods becomes less expensive with reduced interest rates, which increases private consumption.
-In turn, that reduces private saving.
What is the formula for private savings?
Private Savings=Y(Income)-T(Tax Paid)+TR(Transfer Payment)-C(Consumption)
What is the formula for Public Savings?
Public Savings=T(Tax)-TR(Transfer payments)
What is the relation between interest rate and national savings?
-There is a positive relationship between interest rate and national savings.
-That’s because when the interest rate is higher, people want to spend less.
-Private savings go up.
What shifts the supply of loanable funds?
Any factor other than interest rate.
