Chapter 26
Savings, Investment Spending, and the Financial System
Matching Up Savings and Investment Spending
 GDP = Y

Aggregate output (Income) (Y), it is a combined term used to remind you of
the exact equality between aggregate output and aggregate income
 Country’s income is exactly equal to it value of total output or total
expenditures.
The Savings–Investment Spending Identity
 In a simplified economy, two-sector economy
 HH Income-Expenditure equation;
 (1) Total Income = Total Spending
 (2) Total income = Consumption spending + Saving
 Total Expenditure equation;
 (3) Total spending = Consumption spending + Investment spending
 (4) Consumption spending + Savings = Consumption spending +
Investment spending
 (5) Savings = Investment spending
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.
 Y (GDP) = C + S
 Y (GDP) = C + I
 Then; S = I
Here we can summarize that firms can finance money from HH’s savings. In other
words HH supply their saving to firms who use this money in their production
 G = government expenditure on goods and services
 T = Taxes
 TR = transfer payment which is not related to the production of G&S
 Budget balance = T – TR – G
 T > (TR+G) = budget surplus
 T < (TR+G) = budget deficit
 For HH, Yd = disposable income = Y + TR – T.
 In a simplified (three-sector) economy:
 Y (GDP) = C + I + G
(1)
 I=Y–C–G
(2)
 SPrivate = Yd – C = Y (GDP) + TR − T – C
 SGovernment = T − TR – G
 NS = SPrivate + Sgovernment
 = (Y + TR − T − C) + (T − TR − G) = Y − C – G (3)
 I = NS → Investment spending = National savings
 I = NS → Investment spending = National savings
 National savings = private savings + government saving
= the total amount of savings generated within the economy.
 Here we can summarize that firms can finance money from HH’s savings
and government savings. In other words HH and government supply their
saving to firms who use this money in their production.
 In an open economy:
 Y (GDP) = C + I + G + X − IM
(4)
 I = (Y − C − G) + (IM − X) (5)
 (Y − C − G) = private savings and the budget balance
 KI = IM – X = foreigners’ saving
 I = SPrivate + SGovernment + foreigners’ savings (IM − X)
 I = NS + KI
 Investment spending = National savings + Capital inflow
The Savings–Investment Spending Identity
 I = NS + KI
 Investment spending = National savings + Capital inflow
 The savings of people who live in any one country can be used to finance
investment spending that take place in other countries.
 So any given country can receive inflows of funds – foreign savings that
finance investment spending in the country.
 Any given country can also generate outflows of funds – domestic savings
that finance investment spending in another country.
The Market for Loanable Funds
 The loanable funds market is a hypothetical market that examines the
market outcome of the demand for funds generated by borrowers 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.
 The rate of return on a project is the profit earned on the project expressed
as a percentage of its cost.