Chapter 9. Saving and Capital Formation

What factors will increase the willingness of firms to invest in new capital?

1. a decline in the price of new capital goods 2. a decline in the real interest rate 3. technological improvement that raises the marginal product of capital 4. lower taxes on the revenues generated by capital 5. a higher relative price for the firm's output

Consider the following: GDP = 5000 Tax collections = 1000 Gov Transfers and interest payments = 500 Consumption expenditures = 4000 Gov budget surplus = 50 In this case, public saving = ?

50. Remember that public saving (government savings) equals the government budget surplus or deficit..

Why is the demand for saving curve a downward slope?

Because higher interest rates raise the cost of borrowing and reduce firms' willingness to invest.

How to calculate the change in a person's wealth during any period?

Change in wealth = Saving + Capital gains - Capital losses

___ occurs when people use the spending of others as a yard stick to measure their own living standards.

Demonstration effects

What is the difference between stocks and flows?

Ex: think of water running into a bathtub. The amount of water in the rub at any specific moment, 40 gallons at 7:15, is a stock because it is measured at a specific point in time. In contrast, the rate at which the water flows into the tub, say 2 gallons per minute, is a flow because it is measured per unit of time. In many cases, a flow is the rate of change in a stock.

National saving is defined as

GDP minus consumption expenditures minus government purchases of goods and services or Y - C - G

Another way to calculate private saving?

Household saving + business saving

Are capital gains and losses counted as part of savings?

No.

Consider the following: GDP = 5,000 Tax collections = 500 Government transfers and interest payments = 200 Consumption expenditures = 4,000 Government budget deficit = 50 In this case, private saving = ?

Private saving = total private income - net taxes - consumption = GDP - T - C. Given that T (net taxes) = (tax collections - government transfers and interest payments) = 300, we know what private saving = 5,000 - 300 - 4,000 = 700 .

How are public savings and governmental surplus related?

They are identical. When the government collects more taxes than it spends, public saving will be positive. When the government spends more than it collects in taxes so that it runs a deficit, public savings will be negative.

In theory, a higher real interest rate can have both positive and negative effects on savings?

True. A higher interest rate increases the benefit to save, but it also reduces the amount that people need to save each year to reach a given savings target.

Saving is considered

a flow

balance sheet

a list of an economic unit's assets and liabilities on a specific date

flow

a measure that is defined per unit of time

Wealth is considered

a stock

net worth

an economic unit's wealth determined by subtracting liabilities from assets

assets

anything of value that one owns

A balance sheet lists an individual's __ on a particular date.

assets and liabilities.

A stock is a measure that is defined

at a point in time

Increases in the value of existing assets are known as

capital goods

Decreases in the value of existing assets are known as

capital losses

saving

current income minus spending on current needs

Between 1970s and 2005, the U.S saving rate

decreased from 13% to 2.5%

capital losses

decreases in the value of existing assets

The saving __ curve shows the quantity of national saving that households, firms, and the government will choose at each value of the __ interest rate.

demand, supply

A measure that is defined per unit of time is known as __

flow

In the market for saving, the real interest rate:

functions as the "price"

What three groups make up national savings?

households, businesses, and government

capital goods

increases in the value of existing assets

What happens to the investment demand curve when there is an increase for demand?

it shifts to the right

The saving rate of any economic unit is

its saving divided by its income

Saving to meet long-term objectives such as retirement, college attendance, or the purchase of a home is known as __ - __ savings.

life - cycle

stock

measure that is defined at a point in time

If a firm doesn't need to borrow money to buy capital, then the real interest rate __ .

measures the opportunity cost of capital investment

How do you calculate the real interest rate?

nominal interest rate - rate of inflation

The investment demand curve shows the amount

of investment in new capital that firms would choose at each value of the real interest rate

transfer payments

payments the government makes to the public for which it receives no current goods or services' in return

Net tax payments minus government spending equals

public saving

In the market for saving the __ functions as the "price."

real interest rate

The __ interest is the most relevant to savings decisions.

real interest. The real interest rate measures the rate at which the real purchasing power of a financial asset increases over time.

If the government budget deficit increases, the real interest rate will ______ and national savings will ______.

rise ; fall

saving rate

saving divided by income

bequest saving

saving done for the purpose of leaving an inheritance

precautionary saving

saving for protection against unexpected setbacks such as the loss of a job or a medical emergency

life-cycle savings

saving to meet long-term objectives such as retirement, college attendance, or the purchase of a home

The saving supply curve shows the amount

that households, the government and firms are willing to save at each value of the real interest rate.

Public saving is

the amount of the public sector's income that is not spent on current needs

liabilities

the debts one owes

government budget deficit

the excess of government spending over tax collections (G - T) government purchases - tax collections

government budget surplus

the excess of government tax collections over government spending (T - G); the government budget surplus equals public saving

national savings definition

the saving of the entire economy, equal to GDP less consumption expendictures and government purchases of goods and services, or S = Y - C - G S is income

public saving

the saving of the government sector is equal to net tax payments minus government purchases (T-G)

private saving

the saving of the private sector of the economy is equal to the after-tax income of the private sector minus consumption expenditures (Y-T-C); private saving can be further broken down into household saving and business saving

If the government budget deficit increases

the supply of saving will decrease

crowding out

the tendency of increased government deficits to reduce investment spending

wealth

the value of assets minus liabilities

real interest rate

this is the rate relevant to savers because it is the "reward" for saving

national saving

total saving of the U.S. economy

An economic unit's assets minus its liabilities is its

wealth