Saving, Investment and the Financial System (Chapter
13 of Mankiw)
N. Gregory Mankiw, “Principles of Macroeconomics,” 8th Edition, Cengage Learning.
IBE201 Principles of Macroeconomics, Sophia University FLA
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The financial system: the group of institutions that
helps match the saving of one person with the
investment of another.
Financial markets: institutions through which savers
can directly provide funds to borrowers.
Examples:
The Bond Market.
A bond is a certificate of indebtedness.
The Stock Market.
A stock is a claim to partial ownership in a firm.
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Financial Institutions
Financial intermediaries: institutions through which
savers can indirectly provide funds to borrowers.
Examples:
Banks
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Different Kinds of Saving
Private saving=The portion of households’ income
that is not used for consumption or paying taxes
=Y −T −C
Public saving=Tax revenue less government
spending = T − G
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National Saving
National saving=private saving+public saving
= (Y − T − C) + (T − G)
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Saving and Investment
Recall the national income accounting identity: Y =
For the rest of this chapter, focus on the closed
economy case: Y =
Solve for I:
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Budget Deficits and Surpluses
Budget surplus=an excess of tax revenue over
government spending
Budget deficit=a shortfall of tax revenue from
government spending
=
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ACTIVE LEARNING 1: Calculations
Suppose GDP equals $10 trillion, consumption equals
$6.5 trillion, the government spends $2 trillion and has a
budget deficit of $300 billion. Find public saving, taxes,
private saving, national saving, and investment.
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ACTIVE LEARNING 1: How a tax cut affects saving
Use the numbers from the preceding exercise, but suppose
now that the government cuts taxes by $200 billion.
(A) What happens to public saving, private saving,
national saving, and investment if consumers save the full
proceeds of the tax cut?
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ACTIVE LEARNING 1: How a tax cut affects saving
(cont’d)
(B) What happens to public saving, private saving,
national saving, and investment if consumers save 1/4 of
the tax cut and spend the other 3/4?
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The Meaning of Saving and Investment
Private saving is the income remaining after
households pay their taxes and pay for consumption.
Examples of what households do with saving:
Buy corporate bonds or equities
Purchase a certificate of deposit at the bank
Buy shares of a mutual fund
Let accumulate in saving or checking accounts
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The Meaning of Saving and Investment
Investment is the purchase of new capital.
Examples of investment:
General Motors spends $250 million to build a new
factory in Flint, Michigan.
You buy $5000 worth of computer equipment for
your business.
Your parents spend $300,000 to have a new house
built.
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The Market for Loanable Funds
Assume: only one financial market
All savers deposit their saving in this market.
All borrowers take out loans from this market.
There is one interest rate, which is both the return
to saving and the cost of borrowing.
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The Market for Loanable Funds
The supply of loanable funds comes from saving:
Households with extra income can loan it out and earn
interest.
Public saving, if positive, adds to national saving and
the supply of loanable funds.
If negative, it reduces national saving and the supply
of loanable funds.
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The Market for Loanable Funds
The demand for loanable funds comes from investment:
Firms borrow the funds they need to pay for new
equipment, factories, etc.
Households borrow the funds they need to purchase
new houses.
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ACTIVE LEARNING 2: Budget Deficits
Use the loanable funds model to analyze the effects of a
government budget deficit:
Draw the diagram showing the initial equilibrium.
Determine which curve shifts when the government
runs a budget deficit.
Draw the new curve on your diagram.
What happens to the equilibrium values of the interest
rate and investment?
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ACTIVE LEARNING 2: Budget Deficits
(Draw a graph here)
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