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>> Savings, Investment Spending, and the Financial System Section 1: Matching Up Savings and Investment Spending chapter 9 We learned in Chapter 8 that two of the essential ingredients in economic growth are increases in the economy’s levels of human capital and physical capital . Human capi- tal is largely provided by government through public education. (In countries with a large private education sector, like the United States, private post-secondary education is also an important source of human capital.) But physical capital, with the excep- tion of infrastructure, is mainly created through private investment spending—that is, spending by firms rather than by the government. Investment spending must be financed out of savings. There are two sources of savings. One source is domestic savings, created by a country’s own residents. The second source is foreign savings, generated by foreigners. We’ll begin with the sim- plest case, a closed economy —an economy in which there is no economic interaction with the rest of the world. There are no exports, no imports, and no capital flows. In a closed economy, the second source of acquiring savings is unavailable; so, all
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investment spending must come from domestic savings. However, modern economies aren’t closed. So we’ll follow with a discussion of an open economy —an economy in which there is economic interaction with the rest of the world. In an open economy, both sources of investment funds—domestic savings and foreign savings—are available. In both a closed and an open economy, our first step in understanding the process of investment spending is to clarify the relationship between savings and investment spending. Then we can look at how savings is allocated among various investment spending projects available in the economy. The Savings–Investment Spending Identity The most basic point to understand about savings and investment spending is that they are always equal, regardless of whether an economy is open or closed. This is not a the- ory; it’s a fact of accounting called the savings–investment spending identity. To see why the savings–investment spending identity must be true, let’s look again at the national income accounting that we examined in Chapter 7. Recall that GDP is equal to total spending on final goods and services produced in the economy and that we can write the following equation: (9-1) GDP = C + I + G + X IM where C is spending by consumers, I is investment spending, G is government pur- chases of goods and services, X is the value of exports to other countries, and IM is spending on imports from other countries. The Savings–Investment Spending Identity in a Closed Economy In a closed economy, there are no exports or imports. So X = 0 and IM = 0, which makes Equation 9-1 simpler: (9-2) GDP = C + I + G 2 CHAPTER 9 SECTION 1: MATCHING UP SAVINGS AND INVESTMENT SPENDING PITFALLS investment vs. investment spending
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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