Investment and Savings

Investment (I), is the spending for acquiring newly produced physical capital.

Investment (I) = that part of production that is not used for current consumption, e.g. capital goods

Buying an old factory is not an investment for the economy.

Savings (S), household income minus the consumption

If the savings are not under the pillow then,

S = I

is always the case.

Saving (S) = Part of the Income that is not spent (leakage)

Closed Economy without Government Y=C+I

Households earn 7000 because they own factors of production

They spend 5000 and save 2000

So,

Y= C+S

The savings are used for investment So,

S = I is the case. Y = C+ I

Investment is an injection. If:

S > I, the economy contracts

S < I, the economy expands

S = I, the economy is in equilibrium

The financial sector acts as an intermediary between lenders and borrowers

Financial sector: provides transmission services that channel money from savers to borrowers

(incl. Government)

Foreign sector: purchases goods and services (exports), sells goods and services (imports),

generates flows of capital out and into the domestic country (FDI in or out, debt financing, equity capital)

Exports are goods that domestically sold abroad.

Imports are goods that are produced abroad but purchased for use in the domestic economy.

Another way of looking at the ways households, firms, the government, and the rest of the world relate to each other is to consider the markets in which they interact.

We divide the markets into three broad arenas:

the goods-and-services market,

the labor market, and

the money (financial) market.

The four aggregate macroeconomic sectors that form the foundation for macroeconomic analysis are the household sector, the business sector, the government sector, and the foreign sector.

The complete circular flow has five sectors: a household sector, a firm sector, a government sector, a foreign sector, and a financial sector. Different chapters of the book emphasize different pieces of the circular flow, and Figure 16.10 shows us how everything fits together. In the following subsections, we look at the flows into and from each sector in turn. In each case, the balance of the flows into and from each sector underlies a useful economic relationship.

The Firm Sector

Figure 16.10 includes the component of the circular flow associated with the flows into and from the firm sector of an economy. We know that the total flow of dollars from the firm sector measures the total value of production in an economy. The total flow of dollars into the firm sector equals total expenditures on GDP. We therefore know that

production = consumption + investment + government purchases + net exports.

This equation is called the national income identity and is the most fundamental relationship in the national accounts.

By consumption we mean total consumption expenditures by households on final goods and services. Investment refers to the purchase of goods and services that, in one way or another, help to produce more output in the future. Government purchases include all purchases of goods and services by the government. Net exports, which equal exports minus imports, measure the expenditure flows associated with the rest of the world.