Chapter 7
Savings and Investment
Process
© 2000 John Wiley & Sons, Inc.
Chapter Outcomes
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Identify and briefly describe the
major components of the gross
domestic product
Describe how the balance between
exports and imports affects the
gross domestic product
Discuss the link between gross
private domestic investment and
gross savings in the United States
2
Chapter Outcomes
(Continued)
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
Briefly describe the historical role of
savings in the United States
Describe how financial assets and
liabilities are created
Indicate the scope and magnitude of
the federal budget and identify the
principal sources of revenues and
expenditures
3
Chapter Outcomes
(Concluded)
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
Explain the nature of federal
government borrowing and describe
recent trends in borrowing
Identify the major sources of savings
in the United States
Explain how funds flow from savings
into investments
Identify and describe the factors that
affect savings
4
Gross Domestic Product (GDP)
and Capital Formation
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GROSS DOMESTIC PRODUCT:
GDP is a nation’s output of goods
and services for a specified time
CAPITAL FORMATION:
Process of constructing residential
and nonresidential structures,
manufacturing producers’ durable
equipment, and increasing business
inventories
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Gross Domestic Product (GDP)
Components
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EQUATION:
GDP = PCE + GP + GPDI + NE
PERSONAL CONSUMPTION
EXPENDITURES (PCE): Expenditures
by individuals for durable goods,
nondurable goods, and services
GOVERNMENT PURCHASES (GP):
Purchases of goods and services by
the government
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Gross Domestic Product (GDP)
Components (Continued)

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EQUATION:
GDP = PCE + GP + GPDI + NE
GROSS PRIVATE DOMESTIC
INVESTMENTS (GPDI): Investments
in residential and nonresidential
structures, producers’ durable
equipment, and business inventories
NET EXPORTS (NE):
Exports minus imports of goods and
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services
Capital Consumption Allowances
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CAPITAL CONSUMPTION
ALLOWANCES DEFINED:
Estimates of the “using up,” or
depreciation of, plant and equipment
assets for business purposes
IMPORTANCE:
Capital consumption allowances
represent the primary source of
annual savings
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Creation of Financial Assets
and Liabilities
INDIVIDUALS
Real Assets
Financial Liabilities
Financial Assets:
Time Deposits
Owners’ Equity
COMMERCIAL BANK
Real Assets
Financial Liabilities:
Time Deposits
Financial Assets:
Business Loan
Owners’ Equity
BUSINESS FIRM
Real Assets
Financial Liabilities:
Business Loan
Financial Assets
Owners’ Equity
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Creation of Financial Assets
and Liabilities
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REAL ASSETS:
Includes ownership of land,
buildings, machinery, inventory,
commodities, and precious metals
FINANCIAL ASSETS:
Claims in the form of obligations or
liabilities issued by individuals,
businesses, financial intermediaries,
and governments
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Economic Units: Savings Surplus
Versus Savings Deficit
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ECONOMIC UNIT:
Governments, businesses, or
individuals taken as a group
SAVINGS:
Occurs when all of an economic
unit’s income is not consumed but
held in the form of cash and other
financial assets
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Economic Units: Savings Surplus
Versus Savings Deficit (Continued)
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SAVINGS SURPLUS:
Occurs when current income
exceeds investment in real assets
SAVINGS DEFICIT:
Occurs when investment in real
assets exceeds current income
IMPORTANCE OF INDIVIDUALS:
Individuals represent an important
savings surplus economic unit
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Creation of Financial Assets and
Liabilities
Process:
--Individuals place their savings in time
deposit accounts at a bank
--The bank lends some of the deposits
to a business firm
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Creation of Financial Assets and
Liabilities (Continued)
Result:
--Time deposits become financial
assets of savers and financial
liabilities to the bank
--The business loan is a bank’s
financial asset and the business
firm’s financial liability
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Two Types of Financing
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DIRECT FINANCING:
Involves use of securities that
represent specific contracts between
the savers and borrowers
themselves
INDIRECT FINANCING:
Financing created by an intermediary
that involves separate instruments
with lenders and borrowers
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Federal Government Dollar:
Fiscal Year 1999
WHERE IT COMES FROM:
--Individual income taxes (46%)
--Social insurance receipts (34%)
--Corporate income taxes (11%)
--Excise taxes (4%)
--Other (5%)
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Federal Government Dollar:
Fiscal Year 1999 (Continued)
WHERE IT GOES:
--Direct benefit payments for individuals
(50%)
--Grants to states and localities (15%)
--National defense (15%)
--Net interest (14%)
--Other federal operations (5%)
--Reserve pending social security
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reform (1%)
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Federal Budget Concepts
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OFF-BUDGET OUTLAYS:
Funding for some government
agencies that is not included in the
federal budget
BUDGETARY DEFICIT:
Occurs when expenditures are
greater than revenues
FEDERAL STATUTORY DEBT LIMITS:
Limits on the federal debt set by
Congress
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Two Types of Personal Savings
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VOLUNTARY SAVINGS:
Financial assets set aside for future
use
CONTRACTUAL SAVINGS:
Savings accumulated on a regular
schedule by prior agreement (e.g.,
reserves in insurance and pension
plans)
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Personal Savings in the U.S.
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PERSONAL SAVINGS DEFINITION:
Personal income
Less: taxes and other payments
Equals: disposable personal income
Less: personal outlays
Equals: personal savings
SAVINGS RATE DEFINITION:
Savings Rate = (Personal Savings)/
(Disposable Personal Income)
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Types of Personal Savings
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Cash balances
Time and savings deposits
Insurance reserves and pension
funds
Securities
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Corporate Savings in the U.S.
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UNDISTRIBUTED PROFITS
DEFINITION:
Profits before taxes
Less: tax liabilities
Equals: profits after taxes
Less: dividends
Equals: undistributed profits
RETENTION RATE DEFINITION:
Retention Rate = (Undistributed
Profits)/(Profits After Taxes)
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Lending in the Credit Markets:
Financial Intermediation Sources
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Commercial banks
Thrift institutions
Insurance and pension funds
Other financial intermediaries
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Sources of Funds Raised in the
Credit Markets:
By Borrowing Sector
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U.S. government
State and local governments
Households
Farms
Nonfarm noncorporate
Corporate
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Sources of Funds Raised in the
Credit Markets:
By Instrument
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U.S. government securities
Tax-exempt obligations
Corporate bonds
Mortgages
Consumer debt
Bank loans
Other debt
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Factors Affecting Savings
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Levels of income
Economic expectations
Economic cycles
Life stages of the individual saver
Life stages of the corporation
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