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Chapter 21: Problem 3

Briefly explain why the total value of saving in the economy must equal the total value of investment.

Short Answer

Expert verified
In a closed economy, the total value of savings must equal the total value of investment to reach an equilibrium. This is because savings are essentially the supply of funds available for investment, and investment is the demand for those funds. When these two values are equal, the economy is in a balanced state.

Step by step solution

01

Understand the Concept of Saving

Savings is the portion of income that is not spent on consumption. In an economy, savings comes from households who decide to save a part of their income instead of consuming all of it. This is an essential concept of macroeconomics.
02

Understand the Concept of Investment

Investment in economic terms refers to the purchase of goods that are not consumed today but are used in the future to create wealth. In an economy, it is generally businesses that invest. They do this by buying capital goods which can help to produce more goods and services in the future.
03

Relationship Between Saving and Investment

In a closed economy, meaning an economy with no international trade, the total value of savings must be equal to the total value of investment. This is because every unit of currency that is saved is a unit that can potentially be invested. When households decide to save their income, these savings become available to businesses to use for investment. Therefore, savings represents a supply of funds for investment, and investment represents a demand for those funds. When the economy reaches equilibrium, the total value of savings equals the total value of investment.

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