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MACROECONOMICS
Lecturer: DANG HUYEN ANH
Email: [email protected]
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Chapter 3.

SAVING - INVESTMENT
AND THE FINANCIAL SYSTEM

References:

! N. Gregory Mankiw, “Principles

of Economics”, chapters 26, 27
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Outline

I. The Financial System

II. Market for loanable funds

III. Policies of encouraging saving and investment

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If you have spare money but want neither consuming nor doing a business by
yourself, what should you do to get a larger amount in the future???

The answer is, you can deposit money to a bank or you can buy bonds, stock

Buy stocks, Deposit (to

bonds… a bank)

Financial
Financial market FINANCIAL SYSTEM intermediaries
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• Financial system is group of institutions in the economy that help match one
person’s saving with another person’s investment
(Moves the economy’s scarce resources from savers to borrowers)

• Financial institutions include:

• Financial markets
• Financial intermediaries

Financial
intermediaries are
Financial markets institutions that savers
are where savers can indirectly provide
can directly provide funds to borrowers
funds to borrowers.
Financial markets Include:
include -Banks
-The bond market -Mutual funds
-The stock market (Institution that sells shares
to the public, uses the
proceeds to buy a portfolio
of stocks and bonds
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Financial Markets
Bond is a certificate of Stock is a claim to the profits
indebtedness that a firm makes to partial
Bonds are tools used by large ownership in a firm
corporations, the federal Stock prices: demand and supply
government, or state and local
Stock index: Average of a group
governments to borrow from
public of stock prices
! Principal: amount
borrowed
! Date of maturity: when the
loan will be repaid
! Rate of interest: paid
periodically until the date
of maturity
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Saving and investment- the relationship
+ Relationship between Saving and investment

SAVING FINANCIAL INVESTMENT

SYSTEM

Investment is the purchase of

equipment and structures in the
production of goods and services
Including:
Machinery, equipment and
structures
Inventories
New houses
 + What is national saving?
National saving (in short, Saving, S): is Total income in the
economy that remains after paying for consumption and
government purchases
S=Y–C–G
…Some more new phenomenoms,

Net tax (T) = Taxes - Transfer payments

Disposable income (Yd) = Y – T

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…Back to National Income Accounts (GDP)

• Gross domestic product (GDP; Y)

We have, Total income = Total expenditure

Therefore, Y = C + I + G + NX
! Y = GDP (income)
! C = consumption
! I = investment
! G = government purchases
! NX = net exports

Assume closed economy: NX = 0

Therefore, Y=C+I+G
I=Y–C–G (1)
Also, S = Y – G –C
For the (closed)
From (1) and (2), S= I economy as a whole,
one person’s savings
can finance another
person’s investment
Private saving and public saving
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Private saving is Income that households have left after paying for taxes
and consumption
Public saving, is Tax revenue that the government has left after paying
for its spending

From : S = Y – C – G
Add (+T) and (-T) to the equation, we have
! S = (Y – T – C) + (T – G) (1)

• Private saving (Sp): Y – T – C

• Income that households have left after paying for taxes and
consumption

• Public saving (Sg) (government budget), T – G

• Tax revenue that the government has left after paying for its
spending
Budget surplus: T – G > 0
Excess of tax revenue over government spending
Budget deficit: T – G < 0
Shortfall of tax revenue from government spending
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S = SP + S G = I
! If there is a deficit of government budget SG < 0 then
SP – I >0 : the government needs to borrow from private sector to
spend

! If there is a surplus of government budget SG>0 then

SP – I <0 : the private investment is partly financed by the
surplus from government budget
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Now you try

! Suppose GDP is $8 trillion, net taxes are $1.5 trillion, private saving
is $0.5 trillion and public saving is $0.2 trillion. Assuming this
economy is closed, calculate consumption, government purchases,
national saving and investment.
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! Calculate C:

Sp = Y – T – C " C = Y – T –Sp = 8 -1,5-0,5 = 6

- Calculate S:

S = Sp + Sg = 0,5+0,2= 0,7

- Calculate G:

G = T- Sg = 1,5 – 0,2 = 1,3

- Calculate I:

I = Y – C – G = 8 – 6 – 1,3 = 0,7
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The market for Loanable Funds
Supply and demand of loanable funds
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Demand
Supply
Loanabl
e funds
market

! Source of the supply of loanable funds: Saving (national Saving: Sp and Sg)
! Source of the demand for loanable funds: Investment
! Price of a loan: real interest rate (the rate that borrowers pay for a loan and lenders
receive on their saving)
 +As interest rate rises: Real
Interest
Rate

Quantity Quantity
demanded supplied Supply
declines increases
r1
r0
Demand Supply
curve: curve:
Slopes Slopes
downward upward Demand

0 Qd Q0 Qs Quantity of
Loanable Funds

• r is endogenous and causes a movement along the demand and supply

curves
• Other reasons that cause the changes of saving and investment are
exogenous and cause the shift of demand and supply curves
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Effects of a Shift An exogenous change in
SAVING: increase saving
#Supply line shifts to the
Real interest rate right
r #At new equilibrium E1: r
S
reduces to r1 and quantity of
funds increases to Q1
E0
r0

r1
E1
D

Q0 Q1 Quantity
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Effects of a Shift
An exogenous change in
demand : increase demand
#Demand line shifts to the right
#At new equilibrium: r
increases to r1 and quantity of
S
E1 funds increases to Q1
r1

r0
E0

Q0 Q1
 Now You Try...
+ do the following transactions affect real interest rate,
How
quantity of funds transacted, investment, national saving,
private saving and government saving
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Government policies on Loanable funds market
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Gov. policies can affect the economy’s saving and investment:

! Saving incentives
! Investment incentives
! Government budget deficits and surpluses
1. Encourage private saving
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! Sp $ leads to S $ r
S0
"Shift loanable funds supply S1
curve to the right (S0 to S1)
E0
"As a result, the equilibrium
r0
interest rate decreases from
r1 E1
ro to r1, and the equilibrium
quantity of loanable funds
rises from Q0 to Q1
D

Q0 Q1 Q
2. Encourage private investment
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! Encourage private
investment increase
r
demand for funds
S
"The demand curve shift
to the right r1 E1
E0
r0
"As a result: r increases
to r1 and quantity of funds
increases to Q1 D1

D0
Q0 Q1 Quantity
of funds
3. Government budget
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Fiscal policy: is the manipulation of Gov. budget: B = T – G
Tax or Government spending B = 0: balanced budget
B > 0: surplus budget
B < 0: deficit budget
Contractionar
Expansionary
Fiscal Policy:
y Fiscal r
Policy:
increase G or
decrease G or
decrease T
increase T S0
S1
B% B$

E0
! Contractionary Fiscal Policy (G% or r0
T$ ): Increase budget surplus or reduce
budget deficit r1 E1
# SG $

# S curve shifts to the right D

# new equilibrium E1(r1, Q1)

# Government saving increase leads to

Q0 Q1 Q
lower interest rate and supports total
saving
3. Government budget
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! Expansionary Fiscal policy

(G $ or T% )

" Increase budget deficit or reduce budget

deficit r
# SG % # S curve shifts to the left
S1
# new equilibrium E1(r1, Q1) S0

# Government spending increase leads to

higher interest rate and lower Loanable E1
funds quantity in the market r1
r0 E0
Crowding out effect: When the government
spends more than it receives in tax revenue, the
government borrows to finance its budget deficit,
D
it crowds out households and firms that
otherwise would borrow to finance investment
Q1 Q0 Quantity
 NOW YOU TRY…
+ do the following transactions affect real interest rate,
How
quantity of funds transacted, investment, national saving,
private saving and government saving

1. The government increases public expenditures on education by US$1 mln

2. The government increases tax imposed on imports by $1 mln

3. Investment increases by $1 mln thanks to many policies to encourage

domestic investment
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Now you try!
! Suppose GDP is $80, net taxes are $20 trillion, private saving is $5 trillion
and public saving is $2 trillion. Assuming this economy is closed, calculate
consumption, government purchases, national saving and investment

• Calculate C:
Sp = Y – T – C " C = Y – T –Sp = 80 -20-5 = 55

- Calculate S:
S = Sp + Sg = 5+2= 7
- Calculate G:
Sg = T –G
=> G = T- Sg = 20 – 2 = 18
- Calculate I:
I=S=7