Chapter 23: Problem 27

What are the main components of the national savings and investment identity?

Short Answer

Expert verified

The main components of the national savings and investment identity are private savings, public savings, and investment. Private savings (\(S_{private}\)) represent the income households save and can be calculated as \(Y - T - C\), where \(Y\) is total income or GDP, \(T\) is total taxes paid to the government, and \(C\) is total consumption. Public savings (\(S_{public}\)) represent government savings and can be calculated as \(T - G\), where \(T\) is total taxes paid to the government and \(G\) is total government spending. Investment (\(I\)) represents purchases of capital goods and can be calculated as \(Y - C - G\), where \(Y\) is total income or GDP, \(C\) is total consumption, and \(G\) is total government spending. The national savings and investment identity states that total savings (\(S\)) must equal total investment (\(I\)), which can be expressed as \((Y - T - C) + (T - G) = Y - C - G\). This identity ensures the equilibrium and stability of the economy.

Step by step solution

Introduction

The national savings and investment identity shows that the total savings in an economy are equal to the total investment, which is an essential condition for the equilibrium of an economy. This identity can be expressed through the following equation: \[S = I\] where \(S\) represents total savings and \(I\) represents total investment. To understand this identity better, let's break down the main components: private savings, public savings, and investment.

Define Private Savings

Private savings refer to the amount of income that households save, rather than spend on consumption. This can include bank accounts, stocks, bonds, and other financial assets. Mathematically, private savings can be represented as: \[S_{private} = Y - T - C\] where \(Y\) represents total income or Gross Domestic Product (GDP), \(T\) represents total taxes paid to the government, and \(C\) represents total consumption by households.

Define Public Savings

Public savings refer to the amount of income that the government saves, which is the difference between tax revenue and government spending. If tax revenue is greater than government spending, the government has a budget surplus, which contributes positively to national savings. Conversely, if the government spends more than it collects in taxes, it incurs a budget deficit, reducing national savings. Public savings can be represented as: \[S_{public} = T - G\] where T represents total taxes paid to the government and G represents total government spending.

Define Investment

Investment represents the purchases of capital goods, such as machinery, buildings, and equipment, which are used to produce goods and services in an economy. Investment can be done by both private companies and the government, and it is an essential factor in the economic growth and development of a country. In the context of the national savings and investment identity, investment (\(I\)) is equal to: \[I = Y - C - G\] where \(Y\) represents total income or GDP, \(C\) represents total consumption, and \(G\) represents total government spending.

Combine Components to Form the National Savings and Investment Identity

Now that we have defined private savings, public savings, and investment, we can combine them to form the national savings and investment identity. Total savings are the sum of private savings and public savings: \[S = S_{private} + S_{public}\] Using the equations from steps 1-3: \[S = (Y - T - C) + (T - G)\] Since investment is defined as \(I = Y - C - G\), we can equate total savings to investment: \(S = I\) Which shows that: \[(Y - T - C) + (T - G) = Y - C - G\] This equation demonstrates the national savings and investment identity, indicating that the total savings in an economy must equal its total investment, ensuring the equilibrium and stability of the economy.