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Intermediate Macroeconomics Week 5

by: Aaron Notetaker

Intermediate Macroeconomics Week 5 ECON 2202

Marketplace > University of Connecticut > Economics > ECON 2202 > Intermediate Macroeconomics Week 5
Aaron Notetaker

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Saving and Investment supply and demand
Intermediate Macroeconomic Theory
W. Pace
Class Notes
Intermediate, Macroeconomics, savings, investment, supply, demand
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This 3 page Class Notes was uploaded by Aaron Notetaker on Wednesday September 28, 2016. The Class Notes belongs to ECON 2202 at University of Connecticut taught by W. Pace in Fall 2016. Since its upload, it has received 6 views. For similar materials see Intermediate Macroeconomic Theory in Economics at University of Connecticut.


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Date Created: 09/28/16
Intermediate Macroeconomics Week 5 SAVING AND INVESTMENT IN CLOSED AND OPEN ECONOMIES Wealth – amount of holding of assets minus liabilities. Increases by saving more and/or getting a better return on your savings National wealth – country’s holdings of assets minus liabilities. A country with a high saving rate will accumulate wealth over time. Private saving – private disposable income minus consumption expenditure Y D Y – T where YD = disposable income Y = GDP and T = net taxes (taxes – gov’t transfers – interest payments on debt) S P Y – T – C where C = consumption expenditure, Sp = private saving Private saving rate is the proportion of private disposable income that is saved S / P Y D Government spending - Gov’t investment (Ig) gov’t consumption (Cg) Gov’t saving S G T – C (sGrplus if T>G, deficit if T<G) National saving – sum of gov’t and private saving S= Y – C – G National saving rate S / Y Gov’t stimulate saving through - Tax consumption (value-add tax – tax paid by a producer on the difference between what it receives from the sales minus the costs) - Provide tax incentives for saving (401K) - Increase return on saving - Reduce budget deficit (by reducing “crowding out,”- selling treasury bonds, sucking up available loanable funds, raising interest rates) Uses-of-saving identity S = (C + I + G + NX) – C – G = I + NX (remember that NX = exports – imports) Or as the net capital outflow identity S – I = NX Net capital outflow = trade balance - Saving is linked to wealth - Saving is either finance investment or net exports - An increase in net foreign exports (American-owned assets minus foreign- owned US assets) increases wealth Trade surplus if NX>0 Trade deficit if NX<0 Balance of payment accounts – bookkeeping system for recording all receipts and payments between a nation and foreign countries, periodically reports trade balance Up until 1980s, US was largest net creditor in the world, by 2012 net foreign debt was over $3.9 trillion, or 25% of GDP, or US became a large net debtor. The net capital outflow identity can provide answers to how this happened. To understand the link between saving and investment in the long run when all prices are flexible, we assume - The goods market is in equilibrium - A closed economy (NX=0) (no foreign sector) Y = C + I + G Subtracting C and G from both sides then give Saving = Investment Consumption expenditure (C broken into 3 categories) C = C bar+ C (Y – T, r) + - - C bar= autonomous consumption (C that is not interest rate sensitive) - Y – T = disposable income (increase in income or decrease in taxes = more spending) - r = real interest rate (some C is interest rate sensitive) Long-run aggregate output becomes Y = F (K bar)barY bar And so desired saving becomes S = Y bar– Cbar– C (Ybar– Tbarr) – G bar There is a saving-investment diagram: equilibrium in the goods market (a supply and demand for savings and investment) As real interest rates fall, households and firms are more likely to make investments, and so the desired level of investment in the economy will rise Investment function I = I + I(r) where I = autonomous investment bar bar Looking at how the economy responds to changes I saving and investment through changes in - Autonomous consumption A rise in autonomous consumption causes saving and investment to fall and the real interest rate to rise in the long run A fall in AC causes saving and investment to rise and real interest rate to fall - Fiscal policy A rise in taxes causes S and I to rise and r to fall A fall in T causes S and I to fall and r to rise A rise in gov’t spending causes S and I to fall and r to rise A fall in gov’t spending causes S and I to rise and r to fall A rise in gov’t budget deficits causes saving and investment to fall and real interest rates to rise - Autonomous investment Increase in autonomous investment causes S, I and r to rise (caused by optimism and tax breaks) Decrease in AI causes S, I and r to fall (caused by pessimism or raising taxes)


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