Macroeconomics

Course Instructor
Fatema Khatun
Lecturer (Economics)
Department of Business Administration
Bangladesh Army University of Science and Technology
(BAUST), Saidpur
Cell: 01303124952; Email: fatemadba@baust.edu.bd
 Savings and Investment Identities
◼ GDP (denoted as Y) is divided into four components
of expenditure: Y = C + I + G + NX
◼ A closed economy does not engage in international
trade in goods and services, nor does it engage in
international borrowing and lending. So, imports and
exports are exactly zero. Therefore, net exports (NX)
are also zero. In this case, we can write,
Y=C+I+G
or, Y – C – G = I

Chap 1-2
 Savings and Investment Identities
Y–C–G=I
◼ (Y – C – G) is the total income in the economy that remains
after paying for consumption and government purchases: This
amount is called national saving, and is denoted S.
◼ Substituting S for Y – C – G (S = Y – C – G), we can write the
last equation as
S = I.
◼ This equation states that saving equals investment.
◼ Saving is the source of the supply of loanable funds.
◼ Investment is the source of the demand for loanable funds.
Question: Prove that saving equals investment in a closed
economy.
Chap 1-3
 Savings and Investment Identities
Let T denote the amount that the government collects
from households in taxes minus the amount it pays back
to households in the form of transfer payments (such as
Social Security and welfare). We can then write national
saving in either of two ways:
S=Y–C–G
or
S = (Y – T – C) + (T – G).
The second equation separates national saving into two
pieces: private saving (Y – T – C) and public saving (T –
G).
Chap 1-4
 Savings and Investment Identities
◼ Private saving is the amount of income that households have left after
paying their taxes and paying for their consumption. So, private saving
is Y – T – C.
◼ Public saving is the amount of tax revenue that the government has
left after paying for its spending.
◼ If T exceeds G (T > G), the government runs a budget surplus
because it receives more money than it spends. This surplus of (T –
G) represents public saving.
◼ If the government spends more than it receives in tax revenue, then
G is larger than T (G > T). In this case, the government runs a
budget deficit, and public saving (T – G) is a negative number.

Question: Define private saving, public saving, national saving, and

investment. How are they related?
Chap 1-5
 Is govt. deficit budget good for an
economy?
A government runs a fiscal deficit when it spends more than it takes in
from taxes and other revenues.

Chap 1-6
 Is govt. deficit budget good for
an economy?
◼ Factors in favor of deficit
budgets for Bangladesh whether deficit budgets are
◼ Infrastructure Development good for Bangladesh depends
◼ Social Spending on how they are implemented
and the broader economic
◼ Export Promotion
context. While deficit spending
◼ Cushioning Economic Shocks can potentially support
◼ Factors against deficit economic growth and
budgets for Bangladesh development, it must be
carefully managed to avoid
◼ Debt Sustainability
exacerbating existing
◼ Inflationary Pressures vulnerabilities and ensure
◼ External Vulnerabilities long-term fiscal sustainability.
◼ Fiscal Discipline Chap 1-7
 Savings and Investment Identities
1. Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving
is $0.5 trillion, and public saving is $0.2 trillion. Assuming this
economy is closed, calculate consumption, government
purchases, national saving, and investment.
2. Economists in Funlandia, a closed economy, have collected the
following information about the economy for a particular year:
Y = 10,000 C = 6,000 T = 1,500 G = 1,700 The economists also
estimate that the investment function is: I = 3,300 – 100 r, where
r is the country’s real interest rate, expressed as a percentage.
Calculate private saving, public saving, national saving,
investment, and the equilibrium real interest rate.

Chap 1-8
 Market for loanable funds
Market for loanable funds
◼ The market in which those who want to save supply

funds and those who want to borrow to invest demand

funds
◼ Saving is the source of the supply of loanable funds.
◼ Investment is the source of the demand for loanable funds.
Interest Rate
◼ The interest rate is the price of a loan.

◼ It represents the amount that borrowers pay for loans

and the amount that lenders receive on their saving.

Chap 1-9
 Market for loanable funds
Interest Rate
◼ Because a high interest rate makes borrowing more

expensive, the quantity of loanable funds demanded

falls as the interest rate rises.
◼ Similarly, because a high interest rate makes saving

more attractive, the quantity of loanable funds supplied

rises as the interest rate rises.
◼ The demand curve for loanable funds slopes downward,
and the supply curve for loanable funds slopes upward..

Chap 1-10
Market for loanable funds
The interest rate in the
economy adjusts to
balance the supply and
demand for loanable
funds. The supply of
loanable funds comes
from national saving,
including both private
saving and public saving.
The demand for loanable
funds comes from firms
and households that want
to borrow for purposes of
investment. Here the
equilibrium interest rate is
5 percent, and $1,200
billion of loanable funds
are supplied and
demanded.
Chap 1-11
Saving Incentives Increase the
Supply of Loanable Funds
A change in the tax laws
to encourage Americans
to save more would shift
the supply of loanable
funds to the right from S1
to S2 . As a result, the
equilibrium interest rate
would fall, and the lower
interest rate would
stimulate investment.
Here the equilibrium
interest rate falls from 5
percent to 4 percent, and
the equilibrium quantity
of loanable funds saved
and invested rises from
$1,200 billion to $1,600
billion.
Chap 1-12
Investment Incentives Increase the Demand for
Loanable Funds
If the passage of an
investment tax credit
encouraged firms to
invest more, the demand
for loanable funds would
increase. As a result, the
equilibrium interest rate
would rise, and the
higher interest rate
would stimulate saving.
Here, when the demand
curve shifts from D1 to
D2 , the equilibrium
interest rate rises from 5
percent to 6 percent, and
the equilibrium quantity
of loanable funds saved
and invested rises from
$1,200 billion to $1,400
billion.
Chap 1-13
The Effect of a Government Budget Deficit
When the government spends
more than it receives in tax
revenue, the resulting budget
deficit lowers national
saving. The supply of
loanable funds decreases,
and the equilibrium interest
rate rises. Thus, when the
government borrows to
finance its budget deficit, it
crowds out households and
firms that otherwise would
borrow to finance
investment. Here, when the
supply shifts from S1 to S2 ,
the equilibrium interest rate
rises from 5 percent to 6
percent, and the equilibrium
quantity of loanable funds
saved and invested falls from
$1,200 billion to $800
billion. Chap 1-14