Saving and Capital Formation - PowerPoint PPT Presentation

Loading...

PPT – Saving and Capital Formation PowerPoint presentation | free to download - id: 57dae6-MGRjM



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Saving and Capital Formation

Description:

Saving and Capital Formation Principles of Macroeconomics Dr. Gabriel X. Martinez Ave Maria University Introduction Why save? To meet future expenditures. – PowerPoint PPT presentation

Number of Views:178
Avg rating:3.0/5.0
Slides: 65
Provided by: JeffC238
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Saving and Capital Formation


1
Saving and Capital Formation
Principles of Macroeconomics Dr. Gabriel X.
Martinez Ave Maria University
2
Introduction
  • Why save?
  • To meet future expenditures.
  • To protect against an economic emergency.
  • To acquire income-producing assets.
  • For society as a whole, to produce capital goods,
    so to increase future income.

3
Savings and Wealth
  • Saving
  • Current income minus spending on current needs.
  • Confusion Alert Savings is accumulated saving_.
  • If all your wealth comes from saving_ (not
    spending), wealth savings.
  • Saving Rate
  • Saving_ divided by income.

4
Savings and Wealth
  • Example
  • As a graduate student, I earned 10,000 a year,
    and spent about 9,700 a year.
  • My saving was 300 per year.
  • My saving rate was 300/10,000 3.
  • Was my saving rate very low?
  • If I had saved 1,300 a year, my saving rate
    would have been 13.

5
Savings and Wealth
  • Example
  • As a graduate student, I saved 300 per year.
  • Since I was in grad school for 6 years, I saved
    about 300 x 6 1800.
  • So my graduation-day savings were 1800.
  • Saving_ and Income are flows.
  • Savings is a stock.

6
Household Saving Rate in the United States, 1959
- 2006
  • Observations
  • Household saving has fallen dramatically
  • National saving has not declined in recent years

7
Gross Private Saving Rate in the United States,
1959 - 2006
  • Observations
  • Household saving has fallen dramatically
  • National saving has not declined in recent years

8
Gross (National) Saving Rate in the United
States, 1959 - 2006
  • Observations
  • Household saving has fallen dramatically
  • National saving has not declined in recent years

9
Savings and Wealth
  • Wealth
  • The value of assets minus liabilities.
  • Assets
  • Anything of value that one owns.
  • Real Assets, like a car.
  • Financial Assets, like a savings account or a
    bond.
  • Liabilities
  • The debts one owes.

10
Consuelos Balance Sheet
Liabilities Student loan 3,000 Credit card
balance 250
______ Total Liabilities 3,250 Net
worth 3,030
Assets Cash 80 Checking account 1,200 Shares of
stock 1,000 Car (market value) 3,500 Furniture
(market value) 500 Total Assets 6,280
  • Wealth (3,030) Assets (6,280) - Liabilities
    (3,250)

11
Savings and Wealth
  • Flow
  • A measure that is defined per unit of time.
  • Saving is a flow and is defined per unit of time
    (saving/week).
  • Flow is the rate of change in the stock.
  • Stock
  • A measure that is defined at a point in time
  • Wealth is a stock and is defined at a point in
    time (wealth on a given date). Savings are a
    stock too.
  • Every dollar people save addsto their wealth.

12
Savings and Wealth
  • Example

Saving Wealth
10 10
20 30
-10 20
-15 5
35 40
40 80
-40 40
30 70
13
Savings and Wealth
  • Capital Gains
  • Increases in the value of existing assets
  • Capital Losses
  • Decreases in the value of existing assets
  • Change in Wealth
  • Saving Capital gains - Capital loss

14
Consuelos Balance Sheet After An Increase in the
Value of Her Stocks
Liabilities Student loan 3,000 Credit card
balance 250
______ Total Liabilities 3,250 Net
worth 3,530
Assets Cash 80 Checking account 1,200 Shares of
stock (up by 500) 1,500 Car (market
value) 3,500 Furniture (market value)
500 Total Assets 6,780
  • Capital Gains
  • Stock value increases from 1,000 to 1,500
  • Assets increase by 500
  • Wealth increases by 500
  • Capital Loss
  • Reduces wealth

15
The Bull Market of the 1990s
  • Observations
  • During the 1990s, household saving fell while
    wealth rose.
  • Households acquired stocks in the 1990s and stock
    prices rose.
  • 2000 - 2001 the fall in stock prices was offset
    by rising home values.

16
Why Do People Save?
17
Why Do People Save?
  • Life-Cycle Saving
  • Saving to meet long-term objectives, such as
    retirement, college attendance, or the purchase
    of a home.
  • What is the effect of Social Security and Federal
    financial aidon this kind of saving?
  • Precautionary Saving
  • Saving for protection against unexpected
    setbacks, such as the loss of a job or a medical
    emergency.
  • What is the effect of Medicare/aid on this kind
    of saving?
  • Bequest Saving
  • Saving done for the purpose of leaving an
    inheritance.
  • What is the effect of weak family ties on this
    kind of saving?

18
Saving and Wealth
  • If people save for retirement or to diminish
    uncertainty, they save to accumulate wealth.
  • Suppose the value of my stock market (financial)
    investments, or that the value of my house goes
    up.
  • Then my wealth increases.
  • I will save less consume more.
  • This is called the wealth effect.
  • The stock market boom of the 1990s and the
    housing boom of the 2000s have had this effect.

19
Why Do People Save?
  • Saving and the Real Interest Rate
  • The higher the real rate the greater the reward
    from saving.
  • A greater reward may encourage a higher saving
    rate.
  • Financial Liberalization in developing countries
    was carried out with this rationale.

20
Why Do People Save?
Saving S
r
Real interest rate ()
r
S
S
Saving
21
Consumption Trajectories of the Thrifts and the
Spends
Example By how much does a high savings rate
enhance a familys future living standard?
  • Spends save 5 Thrifts save 20
  • Real earnings for both 40,000
  • Both invest in mutual funds with a real yield of
    8
  • By 2015, Thrifts consume 55, 774 and Spends
    consume 43,698
  • By 2015, Thrifts wealth is 385,000 and Spends
    wealth is 77,000

22
Why Do People Save?
  • If people are target savers, a high real interest
    rate may reduce saving.

Saving Interest Income at 10 Wealth
8.5 -- 8.5
8.5 0.85 17.85
8.5 1.79 28.14
8.5 2.81 39.45
8.5 3.94 51.89
8.5 5.19 65.58
8.5 6.56 80.64
8.5 8.06 97.21
Saving Interest Income at 5 Wealth
10 -- 10
10 0.50 20.50
10 1.03 31.53
10 1.58 43.10
10 2.16 55.26
10 2.76 68.02
10 3.40 81.42
10 4.07 95.49
23
Why Do People Save?
  • Saving, Self-Control, and Demonstration Effects
  • Self-Control Hypothesis
  • People lack the self-control to save
  • Techniques to offset the lack of self-control and
    increase savings
  • Payroll savings
  • Retirement accounts with limited withdrawals
  • Factors that may reduce self-control and savings
  • Home equity loans
  • Credit cards with high borrowing limits

24
Why Do People Save?
  • Saving, Self-Control, and Demonstration Effects
  • Demonstration effects
  • People use spending by others to measure the
    adequacy of their own spending.
  • Satisfaction depends on relative living
    standards.
  • An upward spiral of spending can occur, which
    reduces savings.
  • Increased real-wage inequality may contribute to
    this, as well as television and advertising, etc.

25
Components of National Saving
26
National Saving and Its Components
  • The Measurement of National Saving
  • Real income or expenditures (Y) Consumption (C)
    Investment (I) Government (G) Net exports
    (NX)
  • Y C I G NX
  • Saving Y - spending on current needs
  • If we were to assume NX 0
  • Y C I G

27
Net Exports and Foreign Saving
  • NX difference between foreign spending on our
    goods and our spending on foreign goods.
  • If NX lt 0, it must be financed by borrowing from
    abroad.
  • In other words, foreigners must save. NX
    foreign saving.
  • If NX lt 0, foreign saving is positive.
  • See Chapter 24

28
National Saving and Its Components
  • Saving Y - spending on current needs
  • S Y C G

29
National Saving and Its Components
  • The Measurement of National Saving
  • Determining spending on todays needs
  • I spending on capital goods and residential
    housing.
  • C includes durable goods which may be current and
    future needs
  • G may also include current and future needs.
  • Assume that all C and G are current need
    expenditures.
  • National Saving (S) Y C G

30
U.S. National SavingRate, 1960 - 2001
National Saving (S) Y C G
31
National Saving and Its Components
  • Private and Public Components of National Saving
  • National Saving (S) Y - C - G
  • S Y - C - G T - T
  • S (Y - T - C) (T - G)
  • Private saving Sprivate Y - T - C
  • Public saving Spublic T - G

32
National Saving and Its Components
  • Private and Public Components of National Saving
  • National Saving (S) Y - C - G
  • T (net taxes) private-sector tax payments -
    transfer payments and interest payments
  • Private saving Sprivate Y - T - C
  • Public saving Spublic T - G

33
National Saving and Its Components
  • Private and Public Components of National Saving
  • Two components of private saving
    (Sprivate Y - T - C)
  • Household (personal) saving
  • Business saving
  • Makes the majority of US private saving.

34
National Saving and Its Components
  • Private and Public Components of National Saving
  • Spublic T - G
  • Includes
  • Federal
  • State
  • Local

35
National Saving and Its Components
  • Private and Public Components of National Saving
  • S (Y - T - C) (T - G)
  • S Sprivate Spublic
  • National Saving (S) is composed of saving by
    households, businesses, and government

Private
Public
36
National Saving and Its Components
  • Government Budget Deficit (Spublic lt 0)
  • The excess of government spending over tax
    collections (G - T) gt 0.
  • Government saving is negative T lt G.
  • Government Budget Surplus (Spublic gt 0)
  • The excess of government tax collections over
    government spending (T - G) gt 0.
  • Government saving is positive T gt G
  • The government budget surplus equals public
    saving.

37
National Saving and Its Components
  • Public Saving and the Government Budget
  • 2000 Spublic T - G
  • Federal 218.5 2,046.8 - 1,828.3
  • State local 32.8 1,222.6 - 1,189.8
  • Spublic 251.3 3,269.4 - 2,018.1

38
National Saving and Its Components
  • Public Saving and the Government Budget
  • 1995 Spublic T - G
  • Federal -174.4 1,460.3 - 1,634.7
  • State local 111.7 997.7 - 886.0
  • Spublic -62.7 2,458.0 - 2520.7

39
Public Saving, 1947- 2001
40
The Three Components of National Saving, 1960-
2001
41
National Saving and Its Components
  • Is Low Household Saving a Problem?
  • National saving, not household saving, determines
    the capacity of the economy to invest in new
    capital goods.
  • National saving has been reasonably stable
    despite the decline in household saving.
  • The low household saving rate signals a problem
    of growing inequality in wealth among U.S.
    households.
  • It signals a consumerist attitude.

42
Investment and Capital Formation
43
Investment and Capital Formation
  • Investment
  • Investment -- the purchase of new capital goods
    and housing -- is necessary to increase average
    labor productivity.
  • Capital goods will be accumulated only if firms
    want to purchase them.
  • National saving is the source of funding for
    investment.

44
Investment and Capital Formation
  • Investment
  • Investment spending is undertaken if it is
    expected to be profitable.

Benefit from Investment
Profit rate VMP of capital
Profit
Profit
Cost from Investment
Interest rate r
45
Investment and Capital Formation
  • Investment
  • The benefit must exceed the cost of the investment

46
Investment and Capital Formation
  • Investment
  • Suppose I want to buy a unit of capital.
  • While I have it, I receive the benefit of extra
    production, or rather, the benefit of the extra
    revenue that I get from selling that production.
  • Marginal Product x Marginal RevenueValue of
    the Marginal Product

47
Investment and Capital Formation
  • Investment
  • Suppose I want to buy a unit of capital.
  • I could borrow the money from the bank.
  • And pay the loan interest rate.
  • Alternatively, I could take out money from my
    bank account, and buy the machine with it.
  • And lose the saving interest rate.
  • Either way, the interest rate is a key
    determinant of the cost of buying the machine.

48
Investment and Capital Formation
  • Investment
  • The benefit must exceed the cost of the
    investment. In other words
  • The value of marginal product of capital
  • After-tax net revenue per unit, minus the
    opportunity cost (the income from other
    activities that is foregone)
  • must exceed the real interest rate.

49
Investment and Capital Formation
  • Example
  • Should Larry buy a riding lawn mower?
  • Cost of lawn mower 4,000
  • Interest on loan 6
  • Net revenue 6,000
  • Taxes 20
  • Larry could earn 4,400 after tax elsewhere
  • Assume the mower can be resold for 4,000
  • value of liability (loan) value of asset (mower)

50
Investment and Capital Formation
  • Example
  • Should Larry buy a riding lawn mower?
  • Net revenue 6,000
  • Less Taxes (20) 1,200
  • Equal after-tax revenue 4,800
  • Less Opportunity Cost 4,400
  • Equals VMP of lawnmower 400

51
Investment and Capital Formation
  • Example
  • Should Larry buy a riding lawn mower?
  • Net revenue 6,000
  • Less Taxes (20) 1,200
  • Equal after-tax revenue 4,800
  • Less Opportunity Cost 4,400
  • Equals VMP of lawnmower 400
  • Less Interest (6) 240
  • Equals Net Benefit 160

52
Investment and Capital Formation
  • Factors that Determine the Investment Decision
  • Measuring the costs
  • Real interest rate
  • Price of capital goods
  • Suppose that VMP is constant at 400.
  • Then lower interest rates will raise the benefit
    of investment in capital goods.

53
Investment and Capital Formation
r 12 r 10 r 8 r 6 r 4
Net Revenue 6000 6000 6000 6000 6000
Less Taxes 1200 1200 1200 1200 1200
After Tax Revenue 4800 4800 4800 4800 4800
Less Opp. Cost 4400 4400 4400 4400 4400
VMP 400 400 400 400 400
Less Interest 480 400 320 240 160
Net Benefit -80 0 80 160 240
54
Investment and Capital Formation
  • Factors that Determine the Investment Decision
  • Measuring the benefits
  • Value of marginal product
  • Productivity of Capital.
  • The relative price of the good or service
    produced by the capital.
  • Operating expense
  • Maintenance expense
  • Tax liability.

55
Investment and Capital Formation
  • Example
  • Suppose Larry owns a print shop.
  • He would like to buy more than one printer.
  • (it would allow him to run more than one print
    job at the same time). Each costs 5500.
  • Every extra printer brings extra production, but
    at a decreasing rate.
  • Larry has to run around from printer to printer.
  • Theres more of a chance for mistakes.
  • For simplicity, ignore taxes and opportunity
    costs.

56
Investment and Capital Formation
Printers Total Product per year MP per year Price per print job MR Value of the Marginal Product
1 1500 1500 0.50 750
2 2750 1250 0.50 625
3 3750 1000 0.50 500
4 4500 750 0.50 375
5 5000 500 0.50 250
6 5250 250 0.50 125
7 5250 0 0.50 0
57
Investment and Capital Formation
VMP benefit of each additional printer
printers 1 2 3 4 5 6 7
 r 750 625 500 375 250 125 0
r 12 660 90 -35 -160 -285 -410 -535 -660
r 10 550 200 75 -50 -175 -300 -425 -550
r 8 440 310 185 60 -65 -190 -315 -440
r 6 330 420 295 170 45 -80 -205 -330
r 4 220 530 405 280 155 30 -95 -220
Interest paid per printer r 5500
58
Investment and Capital Formation
12
10
8
6
4
1 2 3 4 5 6 7
Interest Rate
Amount of Investment
59
Investment and Capital Formation
Real interest rate ()
r
r
Investment I
I
I
Investment
60
Investment and Capital Formation
  • Economic Naturalist
  • Why has investment in computers increased by so
    much in recent decades?
  • Because the marginal productivity of computers
    has increased tremendously.
  • Higher marginal productivity means higher value
    of the marginal product.
  • More computers become affordable, at the same
    level of interest rates, because they produce
    more.
  • The Investment Curve shifts to the right.

61
Investment and Capital Formation
VMP benefit of each additional printer
printers 1 2 3 4 5 6 7
 r 750 625 500 375 250 125 0
r 12 660 90 -35 -160 -285 -410 -535 -660
r 10 550 200 75 -50 -175 -300 -425 -550
r 8 440 310 185 60 -65 -190 -315 -440
r 6 330 420 295 170 45 -80 -205 -330
r 4 220 530 405 280 155 30 -95 -220
Interest paid per printer r 5500
62
Investment and Capital Formation
VMP increased benefit of each additional printer
  printers 1 2 3 4 5 6 7
r  850 725 600 475 350 225 100
r 12 660 190 65 -60 -185 -310 -435 -560
r 10 550 300 175 50 -75 -200 -325 -450
r 8 440 410 285 160 35 -90 -215 -340
r 6 330 520 395 270 145 20 -105 -230
r 4 220 630 505 380 255 130 5 -120
Interest paid per printer r 5500
63
Investment and Capital Formation
Real interest rate ()
r
I
I
I
Investment
64
Investment in Computers and Software, 1960 - 2001
65
Saving, Investment, and Financial Markets
66
Saving, Investment, and Financial Markets
  • Savings (S)
  • Is the supply of saving
  • The quantity supplied of saving is directly
    related to the real interest rate (r)
  • Investment (I)
  • Is the demand for saving
  • The quantity demanded for saving is inversely
    related to r.

67
Saving, Investment, and Financial Markets
  • Market for Savings
  • The market will determine the equilibrium (r).
  • If r is above equilibrium, a surplus of savings
    will exist.
  • If r is below equilibrium, a shortage of savings
    will exist.

68
The Supply and DemandFor Savings
Real interest rate ()
Saving and investment
69
The Effect of a New Technology on National
Saving and Investment
S
E
Real interest rate ()
r
I
Saving and investment
70
The Effects of An Increase in the Government
Budget Deficit On National Saving and Investment
S
E
Real interest rate ()
r
I
Saving and investment
71
Saving, Investment, and Financial Markets
  • Crowding Out
  • The tendency of increased government deficits to
    reduce investment spending.
  • Higher public deficits reduce national saving.
  • Lower saving at any interest rate creates an
    excess demand for saving funds.
  • Interest rates rise, making investment more
    expensive.
  • Investment falls.
About PowerShow.com