Chapter 8 Tutorial ATW 108 USM

ECONOMY IN THE LONG RUN
Chapter 8
SAVINGS, CAPITAL FORMATION, and
FINANCIAL MARKETS
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• Ants work and save the corn for winter
Saving
• Ants calculate and they have 5 corns
• During Fall season, they consume 2 corns for

daily needs. In other words, their saving is 3
corns.
• So, the saving rate is 3 divided by 5 or 60%

What will happen to Grasshopper?
• The Grasshopper has been suffering during

winter. No Saving, No Assets.
• No Assets means does not have anything. So,
how to survive?
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Going for Debt
• The Grasshopper has to go to ants for corn.

The grasshopper owes ants a corn, which is
usually called as Liabilities
• But yet, Grasshopper is still poor because it
does not have any wealth (even it is
negative!). Why? Zero Assets, 1 liability.
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• If Saving shows the number of assets, the
increasing of saving will increase the Wealth
• ASSETS: All the belongings, including savings

• SAVINGS , and ASSETS .
Wealth is ASSETS minus LIABILITIES. Then,

SAVINGS , ASSETS , and WEALTH .
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What is the conclusion?
• Higher saving rates today lead to faster

accumulation of wealth.
• The Wealthier is the nation, the higher
its standard of living.
• Remember Question 8 chapter 7?
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Problems 1
• Corey’s initial balance sheet:
ASSETS LIABILITIES
Bike $300 Credit card debt $150
Cash $200 Electric bill due $250
Baseball card $400
Checking acct. $1,200
balance
TOTAL $2,100 $400
• Net worth is equal to total assets minus total

liabilities, which equals $1700.
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b. The card is worth zero rather than $400. Assets decline to
$1700, liabilities are unchanged, net worth falls by $400 to
$1300. This is an example of a capital loss; no saving
(positive or negative) has occurred.
c. Liabilities are reduced by $150, assets are unchanged, net
worth increases by $150 to $2250. Note that paying off a
debt out of current income is a form of saving.
d. Assets decline by $150, as the checking account balance
falls from $1200 to $1050. Liabilities also decline by $150,
as the credit card debt falls to zero. Net worth (assets
minus liabilities) is unchanged. No saving has been done
in this case; rather an existing asset was set off against an
existing liability.
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How about if there are many ants?
• If many ants in one region, the aggregate (the

accumulation) of the savings is called as
country saving or NATIONAL SAVING
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How to calculate NATIONAL SAVING?
• First, we have to know the “PRODUCTION”.
• Y = C + I + G + (X-M)
• Let assume there is no trade or Export – equal to
Import, (X-M) will be equal to Zero.
• Y=C+I+G
• If Saving is equal to Income minus expenditure (like
the corn harvested minus corn consumed) and I is
not a spending, the formula is:
• S = Y – (C+G)
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Private Vs Public
• Private saving is the amount
household and business save from
private sector
Public saving is the amount

government save from public sector
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Private has to pay tax to government.
So, Private Saving is equal to Income
(Y) minus Tax (T) minus Consumption (C) or:
Sprivate = Y – T – C
Government takes the tax and
distribute it to Public purpose such as
Infrastructure, Education, Health Security, etc.
The process of Private tax to Public goods is
called as TRANSFER PAYMENT
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• The spending of Government on Public
Services is called as Government Expenditure
(G)
• The Public Saving is equal to Tax (T) minus
Government Expenditure
– Spublic = T – G
Therefore, National Saving is the aggregate of
Private sector plus Public Sector or:
Sprivate + Spublic.
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National Saving, Investment, and
Capital Formation
• Saving shows the amount of asset we have.
• One of the purpose is long run objective such
as Investment
• In other words, Saving shows the provided
funds needed for Investment
• Investment will encourage economic growth.
Increasing economic growth will increase
standard of living
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Illustration
• Ants think they can harvest extra 5 corns if
they have mechanical cutting equipment
• = 10 x
• How ants can get the equipment?

– By using the saving!
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What are the factors that increase
the willingness to invest?
• A decline in the price of new capital goods
• A decline in the real interest rate
• Technological improvement that raises the
marginal product of capital
• Lower taxes on the revenues generated by
capital
• A higher relative price for the firm’s output
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NOTES
• The supply of national saving depends on the saving
decision of household, business, and government
• Demand of saving is the amount of business want to
invest in new capital
• An increase in government budget deficit will reduce
national saving and investment, and raise interest
rate.
• TRADE-OFF between SAVING and FINANCIAL
MARKET
• Fiscal Policy: Taxation, Seigniorage, Borrowing
Money, Consumption of Reserves
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Question 9 Chap. 8
– The investment tax credit effectively lowers the price of new capital
goods to the firm by 10%. Firms’ willingness to invest increases,
raising the demand for saving (I). The real interest rate and the
equilibrium quantities of investment and national saving rise as the
demand for saving (I) curve shifts to the right.
– Increased public saving raises national saving. The supply of saving (S)
curve shifts right. The real interest rate falls and the equilibrium
quantities of investment and national saving rise.
– Increased productivity of new capital goods makes investment more
profitable. The demand for saving (I) curve shifts to the right, raising
the real interest rate and the equilibrium quantities of investment and
national saving.
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– The increased tax on corporate profits reduces the after-tax return to
capital investments (a greater share of the income earned by capital
goes to the government). Firms become less willing to invest, so that
the demand for saving (I) shifts leftward. Public saving is unchanged
by assumption, so the supply of saving curve (S) does not shift. The
real interest rate and the equilibrium quantities of investment and
national saving all decline.
– Increased precautionary saving raises national saving. The supply of
saving (S) curve shifts right. The real interest rate falls and the
equilibrium quantities of investment and national saving rise.
– Increased cost of capital decreases a firm’s willingness to invest,
lowering the demand for saving (I). The real interest rate and the
equilibrium quantities of investment and national saving fall as the
demand for saving (I) curve shifts to the left.
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ECONOMY IN THE LONG RUN

• During Fall season, they consume 2 corns for

• So, the saving rate is 3 divided by 5 or 60%

• The Grasshopper has been suffering during

• The Grasshopper has to go to ants for corn.

• ASSETS: All the belongings, including savings

Wealth is ASSETS minus LIABILITIES. Then,

• Higher saving rates today lead to faster

• Net worth is equal to total assets minus total

• If many ants in one region, the aggregate (the

Public saving is the amount

• How ants can get the equipment?

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