ClassicalModelB.. - The Classical Model: Part B Saving and...

Info iconThis preview shows pages 1–8. Sign up to view the full content.

View Full Document Right Arrow Icon
The Classical Model: Part B Saving and Capital Formation I. Overview We will look at household decisions on saving, aggregate saving and how that feeds into investment and capital formation. We will link consumption, saving, investment and interest rates My approach is very different from Parkin’s “Loanable Funds”
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
II. Consider Robinson Crusoe. Suppose the only good is corn. He harvest 20 bushels of corn, so in this economy Y = 20 bushels Suppose he consumes 18 bushels C = 18 Saving = S = Y – C = 2 Saving rate = S/Y = 0.1, or 10%. Note that Y is current production = current income. Why would he save the corn? - For future consumption - To grow corn next year. “Investment” So S = Y – C = I
Background image of page 2
More Complicated Economy A. Definitions: Saving = current income – spending on current needs Saving rate = saving/current income Think of a household Y = $1,000 per month C = $900 on rent, food, transportation S = Y – C = $100 So saving rate = 10%
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
B. Wealth Definition: Net Worth = Assets - liabilities We can describe net worth using a balance sheet Assets Liabilities Cash $1,000 Mortgage $400,000 Stocks $5,000 Credit Card $10,000 House $500,000 Car $ 6,000 Total assets $512,000 Total liabilities $410,000 So net worth is $102,000
Background image of page 4
C. Relationship between Saving and Wealth Saving is a flow Wealth is a stock Bathtub analogy: Flow: water flowing in - gallons per minute Water level – measure at a point in time. Income and expenditures are flows Level of banks account are stocks. Let Wealth (t) = level of wealth at end of period t
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
C. Relationship between Saving and Wealth - continued Then, Wealth(t) = Wealth(t-1) + Income(t) – Consumption(t) + Return(t) * Wealth(t-1) Return(t) = return on wealth, includes interest rates and capital gains & losses as a percent of initial wealth. So, Change in Wealth from t-1 to t = Saving(t) + Capital Gains (t) - Capital Losses (t)
Background image of page 6
Example: 1990s Stock prices skyrocketed during the 1990s, which led to capital gains, which increased wealth. Some say this is why the saving rate decreased in the 1990s.
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 8
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 28

ClassicalModelB.. - The Classical Model: Part B Saving and...

This preview shows document pages 1 - 8. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online