MACRO - CH 26

The meaning of saving and investment Classify each of the following based on the macroeconomic definitions of saving and investment. Saving Investment Yvette buys new bulldozers for her construction firm. Cho purchases stock in NanoSpeck, a biotech firm. Sean purchases a corporate bond issued by a car company. Bob takes out a mortgage for a new home in Detroit.

The meaning of saving and investment Classify each of the following based on the macroeconomic definitions of saving and investment. Saving Investment Yvette buys new bulldozers for her construction firm. Cho purchases stock in NanoSpeck, a biotech firm. Sean purchases a corporate bond issued by a car company. Bob takes out a mortgage for a new home in Detroit. Points: 1 / 1 National saving is what's left over after you subtract household consumption and government spending from the economy's total income. At the household level, saving is what's left over after subtracting taxes paid and consumption from household income. Depositing unspent income in a bank is an act of saving, as is using unspent income to purchase stocks or bonds. Investment is spending on new capital, such as machines, equipment, tools, or buildings. Also note that spending on new residences is the one component of household expenditures that counts toward investment spending, rather than consumption, in national income accounting.

Saving and investment in the national income accounts The following table contains data for a hypothetical closed economy that uses the dollar as its currency. Suppose GDP in this country is $1,250 million. Enter the amount for investment. National Income Account Value (Millions of dollars) Government Purchases (G) 250 Taxes minus Transfer Payments (T) 300 Consumption (C) 625 Investment (I) Complete the following table by using national income accounting identities to calculate national saving. In your calculations, use data from the preceding table. National Saving (S) = = $ million Complete the following table by using national income accounting identities to calculate private and public saving. In your calculations, use data from the initial table. Private Saving = = $ million Public Saving = = $ million Based on your calculations, the government is running a budget .

GDP = CC + II + (GG -TT) 1250 = 625 +II + 250 1250 = 875 + II II = 1250-875 = 375 Investment = $375 million National Savings = Y-C-G National Savings = 1250-875 = $375 Private savings = GDP - TT -CC Private savings = 1250- 300 - 625 = $325 million Public Savings = TT - GG Public Savings = 300 - 250 = $50 million. Government is running a budget surplus because the public savings are positive. Saving and investment in the national income accounts The following table contains data for a hypothetical closed economy that uses the dollar as its currency. Suppose GDP in this country is $1,250 million. Enter the amount for investment. National Income Account Value (Millions of dollars) Government Purchases (G) 250 Taxes minus Transfer Payments (T) 300 Consumption (C) 625 Investment (I) 375Correct Points: 1 / 1 A closed economy does not trade with the rest of the world, and, thus, its net exports are zero. Therefore, in this case, GDP is the sum of consumption, investment, and government purchases. To find the missing value of investment, the national income accounting identity can be rearranged as follows: C+I+G = Y I = Y−G−C = $1,250 million−$250 million−$625 million = $375 million Complete the following table by using national income accounting identities to calculate national saving. In your calculations, use data from the preceding table. National Saving (S) = Y - C - G Correct = I Correct $375Correctmillion Points: 1 / 1 National saving is the total income in the economy that is left over after paying for consumption and government purchases. In a closed economy, subtracting consumption and government purchases from GDP also yields investment spending, so national saving equals investment: National Saving (S) = Y−C−G = I = $375 million Complete the following table by using national income accounting identities to calculate private and public saving. In your calculations, use data from the initial table. Private Saving = Y - C - T Correct = $325Correctmillion Points: 1 / 1 Public Saving = T - G Correct = $50Correctmillion Points: 1 / 1 Private saving is the income that remains after households pay taxes and make consumption expenditures: Private Saving = Y−C−T = $325 million Public saving is the amount of tax revenue that the government has left over after paying for its spending: Public Saving = T−G = $50 million Based on your calculations, the government is running a budgetsurplus Correct . Points: 1 / 1 When a government spends less than it collects in tax revenues, it runs a government budget surplus. Public saving is positive in the case of a budget surplus. Note that national saving can be thought of as the sum of private and public saving. To verify the national saving figure you derived, add private and public saving: National Saving = Private Saving+Public Saving = (Y−C−T)+(T−G) = $325 million+$50 million = $375 million

Supply and demand for loanable funds The following graph shows the market for loanable funds in a closed economy. The upward-sloping orange line represents the supply of loanable funds, and the downward-sloping blue line represents the demand for loanable funds. 0 100 200 300 400 500 600 700 800 8 7 6 5 4 3 2 1 0 INTEREST RATE (Percent) LOANABLE FUNDS (Billions of dollars) Demand Supply is the source of the supply of loanable funds. As the interest rate falls, the quantity of loanable funds supplied . Suppose the interest rate is 4.5%. Based on the previous graph, the quantity of loanable funds supplied is than the quantity of loans demanded, resulting in a of loanable funds. This would encourage lenders to the interest rates they charge, thereby the quantity of loanable funds supplied and the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of % .

Saving Correct is the source of the supply of loanable funds. As the interest rate falls, the quantity of loanable funds supplieddecreases Correct . Points: 0.5 / 1 The supply of loanable funds comes from people who want to save and lend out some of their income. Savers sometimes lend directly by purchasing bonds in financial markets, or they lend indirectly by depositing funds with financial intermediaries, such as banks, that use the deposits to make loans. The interest rate indicates the return that lenders receive on their saving. The supply of loanable funds curve slopes upward. As the interest rate rises, the return on saving increases, and the quantity of loanable funds supplied increases. As the interest rate falls, saving becomes less attractive and consumption becomes more attractive, so the quantity of loanable funds supplied decreases. Suppose the interest rate is 4.5%. Based on the previous graph, the quantity of loanable funds supplied isgreater Correct than the quantity of loans demanded, resulting in asurplus Correct of loanable funds. This would encourage lenders tolower Correct the interest rates they charge, therebydecreasing Correct the quantity of loanable funds supplied andincreasing Correct the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of 4%Correct.

Saving and investment in the national income accounts The following table contains data for a hypothetical closed economy that uses the dollar as its currency. Suppose GDP in this country is $1,330 million. Enter the amount for consumption. National Income Account Value (Millions of dollars) Government Purchases (G) 350 Taxes minus Transfer Payments (T) 455 Consumption (C) 700 Investment (I) 280 Complete the following table by using national income accounting identities to calculate national saving. In your calculations, use data from the preceding table. National Saving (S) = Y - C - G = I $490 million Complete the following table by using national income accounting identities to calculate private and public saving. In your calculations, use data from the initial table. Private Saving = Y - C - T = $385 million Public Saving = T - G = $105 million Based on your calculations, the government is running a budgetsurplus .

Saving and investment in the national income accounts The following table contains data for a hypothetical closed economy that uses the dollar as its currency. Suppose GDP in this country is $1,330 million. Enter the amount for consumption. National Income Account Value (Millions of dollars) Government Purchases (G) 350 Taxes minus Transfer Payments (T) 455 Consumption (C) 700Correct Investment (I) 280 Points: 1 / 1 A closed economy does not trade with the rest of the world, and, thus, its net exports are zero. Therefore, in this case, GDP is the sum of consumption, investment, and government purchases. To find the missing value of consumption, the national income accounting identity can be rearranged as follows: C+I+G = Y C = Y−G−I = $1,330 million−$350 million−$280 million = $700 million Complete the following table by using national income accounting identities to calculate national saving. In your calculations, use data from the preceding table. National Saving (S) = Y - C - G Correct = I Correct $280 million Points: 0.67 / 1 National saving is the total income in the economy that is left over after paying for consumption and government purchases. In a closed economy, subtracting consumption and government purchases from GDP also yields investment spending, so national saving equals investment: National Saving (S) = Y−C−G = I = $280 million Complete the following table by using national income accounting identities to calculate private and public saving. In your calculations, use data from the initial table. Private Saving = Y - C - T Correct = $175 million Points: 0.5 / 1 Public Saving = T - G Correct = $105 million Points: 1 / 1 Private saving is the income that remains after households pay taxes and make consumption expenditures: Private Saving = Y−C−T = $175 million Public saving is the amount of tax revenue that the government has left over after paying for its spending: Public Saving = T−G = $105 million Based on your calculations, the government is running a budgetsurplus Correct . Points: 1 / 1 When a government spends less than it collects in tax revenues, it runs a government budget surplus. Public saving is positive in the case of a budget surplus. Note that national saving can be thought of as the sum of private and public saving. To verify the national saving figure you derived, add private and public saving: National Saving = Private Saving+Public Saving = (Y−C−T)+(T−G) = $175 million+$105 million = $280 million

The market for loanable funds and government policy The following graph shows the market for loanable funds. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Treat each scenario separately by resetting the graph to its original state before examining the effect of each individual scenario. (Note: You will not be graded on any changes you make to the graph.) Demand Supply INTEREST RATE (Percent) LOANABLE FUNDS (Billions of dollars) Demand Supply Scenario 1: Individual Retirement Accounts (IRAs) allow people to shelter some of their income from taxation. Suppose the maximum annual contribution to such accounts is $5,000 per person. Now suppose there is a decrease in the maximum contribution, from $5,000 to $3,000 per year. Shift the appropriate curve on the graph to reflect this change. This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to and the level of investment spending to . Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government implements a new investment tax credit. Shift the appropriate curve on the graph to reflect this change. The implementation of the new tax credit causes the interest rate to and the level of saving to . Scenario 3: Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes. This change in spending causes the government to run a budget , which national saving. Shift the appropriate curve on the graph to reflect this change. This causes the interest rate to , the level of investment spending.

The market for loanable funds and government policy The following graph shows the market for loanable funds. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Treat each scenario separately by resetting the graph to its original state before examining the effect of each individual scenario. (Note: You will not be graded on any changes you make to the graph.) Demand Supply INTEREST RATE (Percent) LOANABLE FUNDS (Billions of dollars) Demand Supply 50, 50 Scenario 1: Individual Retirement Accounts (IRAs) allow people to shelter some of their income from taxation. Suppose the maximum annual contribution to such accounts is $5,000 per person. Now suppose there is a decrease in the maximum contribution, from $5,000 to $3,000 per year. Shift the appropriate curve on the graph to reflect this change. This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds torise Correct and the level of investment spending todecrease Correct . Points: 0 / 1 Saving is the source of the supply of loanable funds. Reducing the level of saving that households can shelter from income tax will discourage saving at each interest rate, causing the supply of loanable funds to shift to the left. There is a shortage of loanable funds at the initial interest rate. With more willing borrowers than lenders, the lenders will be able to raise the interest rate they charge for loans. As the interest rate rises, the quantity of loanable funds demanded decreases. The equilibrium interest rate rises, and the equilibrium quantity of loanable funds saved and invested falls. Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government implements a new investment tax credit. Shift the appropriate curve on the graph to reflect this change. The implementation of the new tax credit causes the interest rate torise Correct and the level of saving torise Correct . Points: 1 / 1 The implementation of the new investment tax credit will encourage firms to invest more at every interest rate. The policy causes the demand for loanable funds to shift to the right. There is a shortage of loanable funds at the initial interest rate. With more willing borrowers than lenders, the lenders will be able to raise the interest rate they charge for loans. As the interest rate rises, the quantity of loanable funds supplied increases. The equilibrium interest rate rises, and the equilibrium quantity of loanable funds saved and invested rises. Scenario 3: Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes. This change in spending causes the government to run a budgetdeficit Correct , whichdecreases Correct national saving. Points: 1 / 1 Shift the appropriate curve on the graph to reflect this change. This causes the interest rate torise Correct ,crowding out Correct the level of investment spending. Points: 1 / 1 The government moves from a balanced budget to a budget deficit when it increases government spending without changing taxes. Recall that public saving is negative when the government runs a budget deficit. Thus, the deficit subtracts from national saving. Since saving is the source of supply in the market for loanable funds, the reduction in public saving causes the supply of loanable funds to shift to the left. There is a shortage of loanable funds at the initial interest rate. With more willing borrowers than lenders, the lenders will be able to raise the interest rate they charge for loans. As the interest rate rises, the quantity of loanable funds demanded decreases. The equilibrium interest rate rises, and the equilibrium quantity of loanable funds saved and invested falls. Crowding out is the reduction in the level of investment that occurs when the government borrows to finance a budget deficit. Thus, crowding out may occur in this scenario.