Savings, Investments, And The Closed Economy: What's The Link?

In a closed economy, the amount saved is equal to the amount invested. This is because savings are defined as the funds used for investment. This is derived from another identity, which says that in a closed economy with no government, gross domestic product equals gross domestic income. In other words, total output = total income = total expenditure.

However, this does not mean that an increase in savings will lead directly to an increase in investment. For example, if consumers save more and spend less, this could lead to an increase in business inventories. Businesses may respond to this by decreasing output and intended investment, which would reduce income and force an unintended reduction in savings.

This is not to say that savings and investment are separate concepts. In macroeconomic terms, investment is the amount of goods saved for future use, which is, by definition, the same as savings.

In a closed economy, savings equal investment

In a closed economy, savings are indeed considered equal to investment. This is known as the saving-investment identity or the saving-investment principle.

The saving-investment identity is a concept in national income accounting. It states that the amount saved in an economy will be the amount invested in new physical machinery, new inventories, and the like.

In a closed economy with no government, gross domestic product (GDP) is equal to gross domestic income (GDI). This can be expressed as:

> GDI = C + S = C + I = GDP

Where:

• C = Consumption
• S = Savings
• I = Investment
• G = Government
• Y = Income/Output

Therefore, in a closed economy, the remainder of aggregate output (Y), after subtracting consumption by individuals (C) and government (G), must equal investment (I).

However, it is also true that:

> Y = C + S + T

Where:

T = Taxes

This equation says that savings (S) are equal to disposable income (Y-T) minus consumption (C). Combining both expressions and solving for Y-C gives:

> I + G = S + T

> I = S + (T-G)

Here, investment (I) is equal to private savings (S) plus public savings (T-G).

This identity holds true because investment is defined to include inventory accumulation, both deliberate and unintended. For example, if consumers decide to save more and spend less, the fall in demand would lead to an increase in business inventories. This change in inventories brings saving and investment into balance without any intention by businesses to increase investment.

It is important to note that this does not imply that an increase in savings will directly lead to an increase in investment. Businesses may respond to increased inventories by decreasing output and intended investment, which would in turn reduce income and force an unintended reduction in savings.

The saving-investment identity is considered an equilibrium concept. It is derived from the assumption that income (Y) is immediately equal to savings (S), which is then either consumed (C) or invested (I).

In a closed economy, savings can be split into private and public savings

In a closed economy, savings are indeed equal to investment. This is because, in this model, growing capital stock is not the only item taken into account in investment calculations. The other item is inventory accumulation.

In a closed economy, national savings can be split into private and public savings. Private savings refer to the money that households and businesses set aside instead of spending on consumption. This includes money saved in bank accounts, retirement funds, and profits that businesses retain instead of paying out as dividends. Private savings are the lifeblood of a nation's economic potential, contributing to the country's overall savings and investment picture.

Public savings, also known as government savings, are the difference between government revenue and expenditures over a specific period. They are determined by the fiscal policies and budget decisions made by the government. A budget surplus indicates that the government is saving, while a deficit means it is borrowing or using reserves.

The sum of private and public savings equals national savings. National savings represent the total amount of money saved within a country and are crucial for driving long-term economic prosperity. They provide a domestic pool of funds for investment in businesses, infrastructure, and other productive activities, ultimately leading to increased productivity, economic output, and the creation of new jobs.

The interest rate plays a pivotal role in creating an equilibrium between savings and investment in neoclassical economics. Higher interest rates incentivize saving, offering better returns on saved funds, while lower interest rates may make saving less attractive.

In an open economy, the saving-investment identity is: private saving + public saving + foreign saving = private investment + public investment + capital inflow

In an open economy, the saving-investment identity is:

> private saving + public saving + foreign saving = private investment + public investment + capital inflow

This is an "identity", meaning it is true by definition. This identity only holds true because investment here is defined as including inventory accumulation, both deliberate and unintended. Thus, should consumers decide to save more and spend less, the fall in demand would lead to an increase in business inventories. The change in inventories brings saving and investment into balance without any intention by businesses to increase investment.

In this equation, private saving is the total income of a nation that is left over after subtracting consumption and government spending. Public saving is the tax revenue the government has left after it pays all of its expenditures. Foreign saving is the same as a trade deficit, where foreign countries are investing their savings into the domestic economy.

On the other side of the equation, private investment refers to the purchase of new physical capital in an economy, such as machinery. Public investment is the same as government borrowing, where the government needs to borrow when government spending is higher than the taxes collected. Capital inflows refer to net exports, which are considered injections into the economy as the domestic economy is collecting foreign funds.

In an open economy, savings do not equal investments, because we have to account for trade.

The saving-investment identity is true by definition

This identity is derived from another identity, which says that in a closed economy with no government, gross domestic product (GDP) equals gross domestic income (GDI). In national income accounting, any inventory accumulation is counted as investment. Therefore, if consumers decide to save more and spend less, the fall in demand would lead to an increase in business inventories. The change in inventories brings saving and investment into balance without any intention by businesses to increase investment.

The saving-investment identity is also true because saving is defined to include private saving and "public saving" (which is positive when there is a budget surplus, i.e. public debt reduction). In a closed economy with a government, we have:

Y = C + I + G

This means that the remainder of aggregate output (Y), after subtracting consumption by individuals (C) and government (G), must equal investment (I). However, it is also true that:

Y = C + S + T

Where T is the amount of taxes levied. This equation says that saving (S) is equal to disposable income (Y-T) minus consumption (C). Combining both expressions gives:

I + G = S + T

Or:

I = S + (T - G)

Thus, investment is equal to private saving plus "public saving".

The saving-investment identity is an important tool for understanding the determinants of the trade and current account balance. In a nation's financial capital market, the quantity of financial capital supplied at any given time must equal the quantity of financial capital demanded for purposes of making investments. There are two main sources for the supply of financial capital in the US economy: saving by individuals and firms, called S, and the inflow of financial capital from foreign investors, which is equal to the trade deficit (M - X), or imports minus exports. There are also two main sources of demand for financial capital in the US economy: private sector investment, I, and government borrowing, G - T. We can express this national savings and investment identity in algebraic terms:

S + (M - X) = I + (G - T)

This relationship is true as a matter of definition because, for the macro economy, the quantity supplied of financial capital must be equal to the quantity demanded.

The saving-investment identity is not a causal claim

However, this does not imply that an increase in saving must lead directly to an increase in investment. Businesses may respond to increased inventories by decreasing both output and intended investment. This reduction in output by businesses will reduce income, forcing an unintended reduction in saving. Even if the end result of this process is ultimately a lower level of investment, it will nonetheless remain true at any given point in time that the saving-investment identity holds.

The saving-investment identity is derived from another identity, which says that in a closed economy with no government, gross domestic product equals gross domestic income. This means that the remainder of aggregate output, after subtracting consumption by individuals and government, must equal investment. However, it is also true that saving is equal to disposable income minus consumption. Combining both expressions gives:

> Investment = Saving + (Taxes - Government)

This equation is the basis of the investment-savings theory.

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