Personal Saving Rate (S Households /Y) SAVING AND INVESTMENT. Federal Surplus or Deficit (-) Total Private Saving Rate (S Private /Y) 12/18/2009

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1 1 Pesonal Saving Rate (S Households /Y) 2 SAVING AND INVESTMENT Pivate Saving Rate 12-month aveage Total Pivate Saving Rate (S Pivate /Y) Fedeal Suplus o Deficit (-) 3 25% $millions % % % Goss Pivate Saving Rate Goss Business Saving Rate Goss Pesonal Saving Rate Goss Govenment Saving Rate (T-G)/Y US Goss Saving Rate (S pivate +S public )/Y % 6% 4% 2% -2% -4% -6% % -4% 25% 2 15% 1 5%

2 US Investment Rate (I/Y) Net Foeign Capital Inflows (KI/Y) % 2.5% % 1.5% % 0.5% % Basic Tems Motives fo Saving 9 10 Stocks Flows Assets Liabilities Wealth Pesonal Motives Life-cycle, pecautionay, bequest Othe factos (self-contol poblems, demonstation effects) Ean income fom saving in the financial system Give up buying consume goods Then the pice of consuming today (in tems of futue consumption fogone) is the eal inteest ate. Motives fo Saving Motives fo Saving Business Motives Altenative uses of pofits: Distibute them as dividends Buy capital goods o spend on cuent needs Ae the pofit oppotunities cuently open to us, in ou line of business, vey attactive? Save in the financial system How much can we make by putting ou etained eanings on Wall Steet o in the bank? (%) Real inteest ate Saving S High eal inteest ates encouage individuals and fims to save in the financial system. S Saving S 2

3 13 National Saving and Its Components 14 Saving = Y spending on cuent needs COMPONENTS OF NATIONAL SAVING Y C G National Saving and Its Components National Saving and Its Components 15 National Saving (S) = Y - C - G Y - C - G + T - T (Y - T - C) + (T - G) Pivate saving = S pivate = Y - T C Household (pesonal) saving Business saving Public saving = S public = T G Fedeal State Local 16 Govenment Budget Deficit (S public < 0) G - T > 0 Govenment Budget Suplus (S public > 0) T - G > 0 Goss Govenment Saving Rate Saving and Inteest Rates % 6% 4% 18 ( Y T C) + ( T G) Highe inteest ates make consumption moe expensive Highe inteest ates make saving moe attactive 2% -2% -4% ( Y T ) + ( T G) C ( Y T ) + ( T G) [ C a] -6% ( Y T C ) + ( T G) a + 3

4 Saving and Inteest Rates ( Y T C ) + ( T G) a + ate (%) Real inteest a Saving S INVESTMENT AND CAPITAL FORMATION ( Y T ) + ( T G) C S Saving S Investment is the puchase of new capital goods and housing. National saving is the souce of funding fo investment. Investment spending is undetaken if it is expected to be pofitable. Benefit: Maginal Poduct x Maginal Revenue = VMP = Value of the Maginal Poduct Cost: Real Inteest Rate x Debt Benefit fom Investment Pofit Cost fom Investment Pofit ate = VMP of capital Pofit Inteest ate = The inteest ate is a key deteminant of Investment Boow fom the bank, pay the loan inteest ate. Withdaw fom my bank account, miss out on the saving inteest ate. 4

5 25 26 Puchase one moe unit of capital at $4000. Is it pofitable, at diffeent levels of the eal inteest ate? Maginal Poduct = 200 units of output Pice of the output = $2 VMP of this machine is $400. Output Pice VMP Pice of Machine Inteest Rate = 12% = 1 = 8% = 6% = 4% Less Inteest Net Benefit Evey exta machine bings exta poduction, but at a deceasing ate. Machines Total Poduct pe yea MP pe yea Pice pe unit = MR Value of the Maginal Poduct $0.50 $ $0.50 $ $0.50 $ $0.50 $ $0.50 $ $0.50 $ $0.50 $ VMP: benefit of each additional machine VMP: benefit of each additional machine Cost =12% 660 =1 550 = 8% 440 = 6% 330 = 4% 220 Inteest paid pe machine = * $5500 5

6 ) ) 12/18/ VMP: benefit of each additional machine VMP: benefit of each additional machine Cost =12% = = 8% = 6% = 4% Inteest paid pe machine = * $5500 Cost =12% = = 8% = 6% = 4% Inteest paid pe machine = * $ =12% =1 = 8% = 6% =12% =1 = 8% = 6% Real inteest ate (% = 4% = 4% Investment Expeiments An incease in maginal poductivity of capital Highe MP aises VMP, so moe capital is pofitable at the same level of the inteest ate Old VMP Cost =12% Real inteest ate (% = = 8% = 6% = 4% Inteest paid pe machine = * $5500 Investment 6

7 ) ) ) 12/18/ New VMP Cost =12% Real inteest ate (% = = 8% = 6% Expeiments An decline in business confidence Businesses ae less sue of being able to sell. Maginal evenue fom each unit declines. This educes the VMP. = 4% Inteest paid pe machine = * $5500 Investment Old VMP New VMP Cost =12% Real inteest ate (% = = 8% = 6% = 4% Inteest paid pe machine = * $5500 Investment Cost =12% Real inteest ate (% = = 8% = 6% = 4% Inteest paid pe machine = * $5500 Investment 41 Saving, Investment, and Financial Makets 42 SAVING, INVESTMENT, AND FINANCIAL MARKETS Savings (S) Is the supply of saving The quantity supplied of saving is diectly elated to the eal inteest ate () Investment (I) Is the demand fo saving The quantity demanded fo saving is invesely elated to. 7

8 43 Saving, Investment, and Financial Makets 44 The Supply and Demand Fo Savings Maket fo Savings The maket will detemine the equilibium (). If is above equilibium, a suplus of savings will exist. If is below equilibium, a shotage of savings will exist. te (%) Real inteest at Saving S Investment I S, I Saving and investment 45 The Effect of a New Technology on National Saving and Investment 46 The Effects of An Incease in the Govenment Budget Deficit On National Saving and Investment S S S (%) Real inteest ate E F I New Technology Raises the maginal poductivity of capital This inceases the demand fo capital I (%) Real inteest ate F E I Inceases in the govenment budget deficit: Reduces S public and national saving will incease S & I will fall Saving and investment Saving and investment Saving, Investment, and Financial Makets 47 Cowding Out The tendency of inceased govenment deficits to educe investment spending. Highe public deficits educe national saving. Lowe saving at any inteest ate ceates an excess demand fo saving funds. Inteest ates ise, making investment moe expensive. Investment falls. 8