1. Saving and investment academic year 2015/16 Introduction to Economics Augusto Ninni 1

2. Recap of national accounting Y + Q = C + I + G + X Supply = Demand Q = M = Imports Y = C + I + G + X - Q Assumption X = Q (closed economy) Y = C + I + G C + I + G = Z = Aggregate Domestic Demand 2

3. C = C 0 + c 1 (Y d ) Y d = Y – T Z = C 0 + c 1 (Y d ) + I + G Assumption I = I 0 G = G 0 (policy variable) Z = C 0 + I 0 + G 0 + c 1 Y - c 1 T Z = Y Z = c1 Y + (C 0 + I 0 + G 0 - c 1 T) c1 = (marginal) propensity to consume AE = C 0 + I 0 + G 0 - c 1 T 3

4. Z = c1 Y + AE Y = c1 Y + AE Y - c1 Y = AE (1- c1) Y = AE Y = 1 / (1- c1) * AE 1 / (1- c1) = Multiplier Multiplier = > 1 4

5. Equilibrium Supply = Equilibrium Demand = Autonomous Original Demand * > 1 5

6. The equilibrium condition on the goods market is Y=Z We can obtain an equivalent condition based on investment and savings Let’s start from Y = Z = C + I + G We have Y - C - G = I By subtracting and summing T from/to the first term Y - T - C + T - G = I Savings and investments in equilibrium 6

7. Y - T - C + T - G = I The expression Y - T – C is the difference between the available income and consumption -> private saving (S pr ) The expression T – G is the difference between the earnings and costs of the Government -> public saving(S pu ) By substituting in the original expression, we get S pr + S pu = I Private saving + public saving = saving (S) Therefore, the equilibrium condition suggests that S = I Savings and investments in equilibrium 7

8. In equilibrium, investments equal savings -> Say’s Law It is an alternative way of defining the equilibrium in the goods market BUT PAY ATTENTION, WE ARE REFERRING TO A CLOSED ECONOMY….. Savings and investments in equilibrium 8