Saving investment spending And financial system

 Savings and Investment Spending Identity  Saving and investment spending are always equal for the economy as a whole. ▪ GDP =C+I+G+X-IM = Y or Expenditure = Income.

 Closed economy No net exports ▪ GDP = C + G + I ▪ Total income = Total spending ▪ What can we do with income? ▪ Spend or save. ▪ GDP = C + S or  GDP = Consumption spending (C+G) + savings (S) ▪ If that is the case ▪ Consumer spending (C) + Government spending (G) + Investment spending (I) should = Consumer spending (C) + Government spending (G) + savings (S) ▪ Or C+G+I = C+G+S ▪ So Savings (S) = Investment (I)

 Remember Not just households save.  Government can save as well  Government savings = Tax revenue (T) – Government consumption (G) – transfer payments (TR) ▪ Budget deficit – Government savings is negative. We are spending more than receiving in Taxes. (dissavings) ▪ Budget surplus – Government savings is positive. We are spending less than we are receiving in Taxes. ▪ Balanced Budget – Government savings is 0

 National saving  Private savings + Government savings  So we can say ▪ National savings = investment (I)

 The savings Investment spending identity changes in an Open economy.  Open economy ▪ Allows money, and goods and services to flow between nations. ▪ Foreign Saving can be used in domestic investments (Inflows) ▪ Domestic saving can be used in foreign investments (outflows) ▪ Net capital inflows ▪ Is the total inflow of funds into a country minus the total outflow of funds out of a country

 Net capital inflows can be negative  You can also say Net capital inflow (NCI)= Imports (IM) – exports (X) ▪ NCI = Imports-exports ▪ I = (GDP- C- G) + (IM – X) ▪ I = NATIONAL SAVINGS + (IM- X) ▪ I = NATIONAL SAVINGS + NCI

r Quantity of loanable funds = investment S= Supply of loanable funds: comes from those who are savers. National Savings = Private savings + Government Savings + Net capital inflows

 Shift in supply for loanable funds  Changes in private savings behavior ▪ Private savings increase shift to right ▪ Private savings decrease shift to the left  Changes in net capital inflows ▪ Net capital inflows increase shift to the right ▪ Net capital inflows decrease shift to the left.  Changes in government borrowing needs. ▪ Can shift either the Demand curve or the supply curve for loanable funds ▪ Government greater demands for loans can shift  Demand to the right  Supply to the left ▪ Government less need for loans can shift  Demand left  Or supply right

r = Real interest rate Quantity of loanable funds = investment Demand = D demand for loans :originates from those who want loans. To want a loan one looks at Rate of return. IF Rate of Return > real Interest rate. One is willing to borrow. If Rate of Return < real interest rate one is willing to save

 Shifts in the Demand for loanable funds  Changes in perceived business opportunities ▪ Changes about belief of payoffs from investments ▪ Greater payoffs shift to the right ▪ Smaller payoffs shift to the left  Changes in government borrowing ▪ Government running at a deficit will have a greater demand of loanable funds. Shift to the right ▪ Government running at a surplus will have no need to go to loanable funds market. Shift to the left

 When Interest Rates rise Consumers and Business Save more than they spend.  Greater incentive to Save then to spend.  Earn greater future purchasing power then investing in new projects.  So When government’s need for loans pushes interest rates higher “crowding out” occurs.  Demand for loans from business and individuals decrease.