Derived Savings Investment GDP Leakage GDP C I

Derived Savings = Investment

GDP Leakage • GDP = C + I + G + (X – M) • Leakage to GDP: S+T+M (S = Savings T= taxes M = Imports) • Injections to GDP: I+G+X (Investment, Gov’t, Exports) • Only in equilibrium do: Leakage = Injections S+T+M=I+G+X

Deriving Savings • GDP is Y = C + I + G + NX • If you assume a closed economy – (one that does not engage in trade) Y=C+I+G • Subtract C & G from both sides => • Since Savings = Investment: Y–C–G=I Savings = Y – C – G

National, Private & Public Savings • National Saving = sum of public + private savings – supply curve for loanable funds – Equals Y – C – G • Private Saving – Income households have after taxes & consumption – Equals Y – T – C (T=Taxes) • Public Saving – Tax revenue left after government spending – Equals T – G (T=Taxes)

The investment demand curve is the Demand Curve in Loanable Funds Investment Real Interest Rate Id $ Investment Roi = Return on investment real interest rate = r If ror Ror = Return adjusted for inflation > r => then make investment

Practice Tests

Investment • Investment has 3 subcomponents: Real Interest Rate – New capital expenditure by firms – New construction Id • factories by business & housing by households – Net inventories (unsold) $ Investment Capital Goods: GDP counts goods when built----not when sold! Most important component of I Firm builds new plants or ↑ # of machines etc… Step #1 (short run)=> AD ↑ Step #2 (long run) => LRAS ↑ & PPF ↑ (full potential ↑)

Example: Investing Incentives • A tax credit on capital investment Capital Goods Real Interest Rate r a) Demand Increases Due to Gov’t incentive S 1 ------------------ E 2 r 1 ------- E 1 2 Q 1 Q 2 b) AD ↑ because I ↑ D 1 D 2 c) More Investment today leads to ↑PPF & LRAS in long run Qty Loanable Funds

Government Policies • Gov’t Policies greatly affect Saving & Investment • Gov’t Incentives: – Lower Taxes on Savings • Interest on bonds, dividends on stocks • ↑ supply of loanable funds which lowers the real interest rate – Tax credits on Investment • Tax credits on purchase of capital goods

Changing Saving Incentives Real Interest Rate Supply, S 1 S 2 Tax incentives for saving increase the supply of loanable funds. . . 5% 4% 2. . which reduces the equilibrium interest rate. . . Demand 0 $1, 200 $1, 600 3. . and raises the equilibrium quantity of loanable funds. Loanable Funds (in billions of dollars)