Chapter 26 - Saving, Investment, and the Financial System

Vocabulary
Financial System


 * Definition: The group of institutions in the economy that help to match one person's saving with another person's investment.


 * What It Means:

Financial Markets


 * Definition: Financial institutions through which savers can directly provide funds to borrowers.


 * What It Means:

Bond


 * Definition: A certificate of indebtedness.


 * What It Means:

Stock


 * Definition: A claim to partial ownership in a firm.


 * What It Means:

Financial Intermediaries


 * Definition: Financial institutions through which savers can indirectly provide funds to borrowers.


 * What It Means:

Mutual Fund


 * Definition: An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds.


 * What It Means:

National Saving (Saving)


 * Definition: The total income in the economy that remains after paying for consumption and government purchases.


 * What It Means:

Private Saving


 * Definition: The income that households have left after paying for taxes and consumption.


 * What It Means:

Public Saving


 * Definition: The tax revenue that the government has left after paying for its spending.


 * What It Means:

Budget Surplus


 * Definition: An excess of tax revenue over government spending.


 * What It Means:

Budget Deficit


 * Definition: A shortfall of tax revenue from government spending.


 * What It Means:

Market for Loanable Funds


 * Definition: The market in which those who want to save supply funds and those who want to borrow to invest demand funds.


 * What It Means:

Crowding Out


 * Definition: A decrease in investment that results from government borrowing.


 * What It Means:

Equations
Y = GDP (Gross Domestic Product)

C = Consumption

I = Investment

G = Government Purchases

NX = Net Exports (When in a closed economy, NX can be omitted)

T = Taxes

GDP:

Y = C + I + G + NX

Thus, GDP is the sum of Consumption, Investment, Government spending, and Net Exports.

National Saving (Saving):

I = Y - C - G

I = S

S = Y - C - G    or     S = (Y - T - C) + (T - G)

The second equation (S = (Y - T - C) + (T - G)) shows the addition of Private Saving (Y - T - C) and Public Saving (T - G). When added together to find national saving, the T's cancel out, and you are left with the first equation (S = Y - C - G).

Private Saving:

= Y - T - C

GDP is the same thing as private income. Thus, Private Saving is the amount of income that households have left after paying their taxes and paying for their consumption.

Public Saving:

= T - G

Public Saving is the amount of tax revenue that the government has left after paying for its spending.

T, taxes, is a source of income for the government. If T is larger than G (government spending), the equation will be positive. The government is receiving more money than it is spending. This means that there is a budget surplus.

If T is less than G, the equation will be negative. The government is spending more money than it is receiving. This means that there is a budget deficit.