Chapter 7 Savings and Investment Process © 2000 John Wiley & Sons, Inc.

2 Chapter Outcomes n Identify and briefly describe the major components of the gross domestic product n Describe how the balance between exports and imports affects the gross domestic product n Discuss the link between gross private domestic investment and gross savings in the United States

3 Chapter Outcomes (Continued) n Briefly describe the historical role of savings in the United States n Describe how financial assets and liabilities are created n Indicate the scope and magnitude of the federal budget and identify the principal sources of revenues and expenditures

4 Chapter Outcomes (Concluded) n Explain the nature of federal government borrowing and describe recent trends in borrowing n Identify the major sources of savings in the United States n Explain how funds flow from savings into investments n Identify and describe the factors that affect savings

5 Gross Domestic Product (GDP) and Capital Formation n GROSS DOMESTIC PRODUCT: n GROSS DOMESTIC PRODUCT: GDP is a nation’s output of goods and services for a specified time n CAPITAL FORMATION: n CAPITAL FORMATION: Process of constructing residential and nonresidential structures, manufacturing producers’ durable equipment, and increasing business inventories

6 Gross Domestic Product (GDP) Components n EQUATION: n EQUATION: GDP = PCE + GP + GPDI + NE n PERSONAL CONSUMPTION EXPENDITURES (PCE): n PERSONAL CONSUMPTION EXPENDITURES (PCE): Expenditures by individuals for durable goods, nondurable goods, and services n GOVERNMENT PURCHASES (GP): n GOVERNMENT PURCHASES (GP): Purchases of goods and services by the government

7 Gross Domestic Product (GDP) Components (Continued) n EQUATION: n EQUATION: GDP = PCE + GP + GPDI + NE n GROSS PRIVATE DOMESTIC INVESTMENTS (GPDI): n GROSS PRIVATE DOMESTIC INVESTMENTS (GPDI): Investments in residential and nonresidential structures, producers’ durable equipment, and business inventories n NET EXPORTS (NE): n NET EXPORTS (NE): Exports minus imports of goods and services

8 Capital Consumption Allowances n CAPITAL CONSUMPTION ALLOWANCES DEFINED: Estimates of the “using up,” or depreciation of, plant and equipment assets for business purposes n IMPORTANCE: Capital consumption allowances represent the primary source of annual savings

9 Creation of Financial Assets and Liabilities INDIVIDUALS COMMERCIAL BANK BUSINESS FIRM Real Assets Financial Assets: Time Deposits Financial Liabilities Owners’ Equity Real Assets Financial Assets: Business Loan Financial Liabilities: Time Deposits Owners’ Equity Real Assets Financial Assets Financial Liabilities: Business Loan Owners’ Equity

10 Creation of Financial Assets and Liabilities n REAL ASSETS: Includes ownership of land, buildings, machinery, inventory, commodities, and precious metals n FINANCIAL ASSETS: Claims in the form of obligations or liabilities issued by individuals, businesses, financial intermediaries, and governments

11 Economic Units: Savings Surplus Versus Savings Deficit n ECONOMIC UNIT: Governments, businesses, or individuals taken as a group n SAVINGS: Occurs when all of an economic unit’s income is not consumed but held in the form of cash and other financial assets

12 Economic Units: Savings Surplus Versus Savings Deficit (Continued) n SAVINGS SURPLUS: Occurs when current income exceeds investment in real assets n SAVINGS DEFICIT: Occurs when investment in real assets exceeds current income n IMPORTANCE OF INDIVIDUALS: Individuals represent an important savings surplus economic unit

13 Creation of Financial Assets and Liabilities n Process: --Individuals place their savings in time deposit accounts at a bank --The bank lends some of the deposits to a business firm

14 Creation of Financial Assets and Liabilities (Continued) n Result: --Time deposits become financial assets of savers and financial liabilities to the bank --The business loan is a bank’s financial asset and the business firm’s financial liability

15 Two Types of Financing n DIRECT FINANCING: Involves use of securities that represent specific contracts between the savers and borrowers themselves n INDIRECT FINANCING: Financing created by an intermediary that involves separate instruments with lenders and borrowers

16 Federal Government Dollar: Fiscal Year 1999 n WHERE IT COMES FROM: --Individual income taxes (46%) --Social insurance receipts (34%) --Corporate income taxes (11%) --Excise taxes (4%) --Other (5%)

17 Federal Government Dollar: Fiscal Year 1999 (Continued) n WHERE IT GOES: --Direct benefit payments for individuals (50%) --Grants to states and localities (15%) --National defense (15%) --Net interest (14%) --Other federal operations (5%) --Reserve pending social security reform (1%)

18 Federal Budget Concepts n OFF-BUDGET OUTLAYS: Funding for some government agencies that is not included in the federal budget n BUDGETARY DEFICIT: Occurs when expenditures are greater than revenues n FEDERAL STATUTORY DEBT LIMITS: Limits on the federal debt set by Congress

19 Two Types of Personal Savings n VOLUNTARY SAVINGS: n VOLUNTARY SAVINGS: Financial assets set aside for future use n CONTRACTUAL SAVINGS: n CONTRACTUAL SAVINGS: Savings accumulated on a regular schedule by prior agreement (e.g., reserves in insurance and pension plans)

20 Personal Savings in the U.S. n PERSONAL SAVINGS DEFINITION: n PERSONAL SAVINGS DEFINITION: Personal income Less: taxes and other payments Equals: disposable personal income Less: personal outlays Equals: personal savings n SAVINGS RATE DEFINITION: n SAVINGS RATE DEFINITION: Savings Rate = (Personal Savings)/ (Disposable Personal Income)

21 Types of Personal Savings n Cash balances n Time and savings deposits n Insurance reserves and pension funds n Securities

22 Corporate Savings in the U.S. n UNDISTRIBUTED PROFITS DEFINITION: Profits before taxes Less: tax liabilities Equals: profits after taxes Less: dividends Equals: undistributed profits n RETENTION RATE DEFINITION: Retention Rate = (Undistributed Profits)/(Profits After Taxes)

23 Lending in the Credit Markets: Financial Intermediation Sources n Commercial banks n Thrift institutions n Insurance and pension funds n Other financial intermediaries

24 Sources of Funds Raised in the Credit Markets: By Borrowing Sector n U.S. government n State and local governments n Households n Farms n Nonfarm noncorporate n Corporate

25 Sources of Funds Raised in the Credit Markets: By Instrument n U.S. government securities n Tax-exempt obligations n Corporate bonds n Mortgages n Consumer debt n Bank loans n Other debt

26 Factors Affecting Savings n Levels of income n Economic expectations n Economic cycles n Life stages of the individual saver n Life stages of the corporation