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Lecture

ECON105-ch10 .pdf

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Department
Economics
Course
ECON 105
Professor
Gulriz Barkin
Semester
Spring

Description
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 spending. ▯ The budget deficit is the difference between tax revenue and government spending when government spending exceeds tax revenue. ▯ The budget balance is the difference between tax revenue and government spending. ▯ 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 1 Chapter 10: Savings and Investment Spending 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). Source:OECD 2 Chapter 10: Savings and Investment Spending 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 holds. ▯ Similarly, if households suddenly decide to save less and spend more, inventories will drop—and this will be counted as negative investment spending. 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 it? The Demand Curve for Loanable Funds: 3 Chapter 10: Savings and Investment Spending 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: 4 Chapter 10: Savings and Investment Spending 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. 5 Chapter 10: Savings and Investment Spending 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 revenues. 6 Chapter 10: Savings and
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