Chapter 10: Savings and Investment Spending
Two of the essential ingredients in growth are increases in human capital
and physical capital. Human capital is largely provided by government
through public education. But physical capital, with the exception of
infrastructure, is mainly created through private investment spending (I) -
that is spending by firms rather than by the government.
Matching Up Savings and Investment Spending
▯ According to the savings–investment spending identity,savings and
investment spending are always equal for the economy as a whole.
▯ The budget surplus is the difference between tax revenue and
government spending when tax revenue exceeds government
▯ The budget deficit is the difference between tax revenue and
government spending when government spending exceeds tax
▯ The budget balance is the difference between tax revenue and
▯ National savings,the sum of private savings plus the budget balance,
is the total amount of savings generated within the economy.
▯ Capital inflow is the net inflow of funds into a country.
The Savings-Investment Identity in a closed economy (no trade):
The Savings-Investment Identity in an open economy
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The Savings-Investment Spending Identity in Open Economies: Canada
2007 and 2010
In 2007, national savings was 25.1% of GDP and exceeded domestic investment (equal to 23.2% of GDP).
Canada used the excess amount of funds to invest abroad (positive NFI equal to 1.9% of GDP). The reverse
situation occurred in 2010. National savings (20.3%of GDP) was less than investment spending (22.2% of
GDP); the shortfall was covered by borrowing from abroad (a negative NFI).
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Who Enforces the Accounting?
▯ The savings–investment spending identity is a factof accounting. By
definition, savings equals investment spending for the economy as a
whole. But who enforces the arithmetic?
▯ The short answer is that actual anddesired investment spending aren’t
always equal. Suppose that households suddenly decide to save more
by spending less. The immediate effect will be that unsold goods pile
up. And this increase in inventory counts as investment spending,
albeit unintended. So the savings–investment spending identity still
▯ Similarly, if households suddenly decide to save less and spend more,
inventories will drop—and this will be counted as negative investment
The Market for Loanable Funds
▯The loanable funds marketis a hypothetical market that examines the
market outcome of the demand for funds generated byborrowers and the
supply of funds provided by lenders.
The interest rate is the price, calculated as a percentage of the amount
borrowed, charged by the lender to a borrower for the use of their savings
for one year. Both borrowers and lenders are interested in the real interest
they will pay and receive so the market for loanable funds determines the
real interest rate rather than the nominal interest rate.
The Demand for Loanable Funds: The quantity of loanable funds
demanded is the total quantity demanded to
What determines investment and the demand for loanb ale funds to finance
The Demand Curve for Loanable Funds:
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Changes in the Demand for Loanable Funds:
The Supply of Loanable Funds:
The quantity of loanable funds supplied is the total quantity supplied by
What determines how much of your income to save and supply in the
loanable funds market?
The supply Curve of Loanable Funds
Changes in the Supply of Loanable Funds:
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Equilibrium in the Loanable Funds Market
The equilibrium interest rate is the interest rateat which quantity demanded
for loanable funds is equal to quantity supplied of loanable funds.
Here, the equilibrium interest rate is 8%, with
$300 billion of funds lent and borrowed.
Investment spending projects with a rate of
return of 8% or higher receive funding; those
with a lower rate of return do not. Lenders
who demand an interest rate of 8% or lower
have their offers of loans accepted; those who
demand a higher interest rate do not.
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Changes in Demand and Supply
Increase in demand:
Increase in supply:
Government in the Loanable Funds Market
• When the government runs a budget deficit, it must borrow in the
loanable funds market to finance the gap between expenditures and
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