Lecture Principles of economics (Asia Global Edition) - Chapter 19

Saving, Capital Formation, and
Financial Markets
Chapter 19

McGraw­Hill/Irwin

Copyright © 2015 by McGraw­Hill Education (Asia). All rights reserved.
19­1


Learning Objectives
1.

2.

3.
4.

5.

Explain the relationship between savings and
wealth
Identify and apply the components of national
saving
Discuss the reasons why people save
Discuss the reasons why firms choose to invest
in capital rather than financial assets
Analyze financial markets using the tools of
supply and demand

19­2

Savings and Wealth
•

Saving is current income minus spending on
current needs
–

•

The saving rate is saving divided by income

Wealth is the value of assets minus liabilities
–
–
–

Assets are anything of value that one owns
Liabilities are the debts one owes
The balance sheet is a list of an economic unit’s
assets and liabilities
•
•

Specific date
Economic unit (business, household, etc.)
19­3

Individual Balance Sheet, 1/1/14
Assets
Cash
Checking account
Shares of stock

$80
1,200
1,000

Car (market value)

3,500

Furniture (market value)
Total

Liabilities
Student loan
Credit card balance

$3,000
250

500
$6,280

$3,250
Net worth

$3,030

19­4


Flow Values and Stock Values
•

A flow value is defined per unit of time
–
–

•

Wealth

■ Debt

The flow of savings causes the stock of wealth
to change
–

•

■ Spending
■ Wage

A stock value is defined at a point in time
–

•

Income
Saving

Every dollar a person saves adds to his wealth

A high rate of saving today leads to an improved
standard of living in the future
19­5


Capital Gains and Losses
•

Wealth changes when the value of your assets
change
–

Capital gains increase the value of existing assets
•

–

Higher value for stock

Capital losses decreases the value of existing
assets
•

Car accident damages bumper and front headlight

Change in wealth =
Saving + Capital gains – Capital losses

19­6


US Stock Prices, 1960 - 2004

19­7


The Bull Market of the 1990s
•

Stock ownership increased
–
–
–

•

Direct purchases
Mutual funds
Pension and retirement funds

Stock prices rose rapidly
–

Capital gains on stocks increased household wealth
•

•

May have decreased household savings

Stock market declined, 2000 – 2002
–
–

Household savings remained low
Value of privately-owned homes increased rapidly
19­8


National Savings
•

Macroeconomics studies total savings in the
economy
–
–

•

Household savings is one component
Business and government savings are other parts

Start with the definition of production and income

for the economy
Y = C + I + G + NX
Y = aggregate income
C = consumption
expenditure
I = investment spending

G = government
purchases of goods
and services
NX = net exports
19­9


Calculate National Savings
•
•

Assume NX = 0 for simplicity
National savings (S) is current income less
spending on current needs
–

•

Current income is GDP or Y

Spending on current needs
–
–

Exclude all investment spending (I)
Most consumption and government spending is for
current needs
•

For simplicity, we assume all of C and all of G are for
current needs

S=Y–C–G
19­10


National Savings, 1960 - 2011
•

Since 1960, US national savings rate has been 11–
21% whereas Singapore has much higher rate
– Less volatile than household savings
12
10
Singapore

Nat ional Saving Ratio (% )
8
6
4

United States

2
0

1960

1970

1980

Year

1990

2000

2010
19­11


Private Saving
•
•
•

Private saving is household plus business saving
Household's total income is Y
Households pay taxes (T) from this income
– Government transfer payments increase household
income
•

–

Transfer payments are made by the government to
households without receiving any goods in return

Interest is paid to government bond holders

T = Taxes – Transfers – Government interest
payments
19­12


Private Saving
•

•

Private saving is after-tax income less consumption
SPRIVATE = Y – T – C
Private saving is done by households and
businesses
–
–

Household saving or personal saving is done by families
and individuals
Business savings makes up the majority of private
saving in the US
•

Business savings is revenues less operating costs
less dividends to shareholders
•
Business savings can purchase new capital
equipment
19­13


Public Saving and National
Saving

•

•

Public saving is the amount of the public sector's income
that is not spend on current needs
– Public sector income is net taxes
– Public sector spending on current needs is G
SPUBLIC = T – G
National saving (S) is private savings plus public savings
SPRIVATE + SPUBLIC = (Y – T – C) + (T – G)
S=Y–C–G
19­14


The Government Budget
•

Balanced budget occurs when government

spending equals net tax receipts
–

Government budget surplus is the excess of
government net tax collections over spending (T –
G)
•

–

Budget surplus is public savings

Government budget deficit is the excess of
government spending over net tax collections
•

Budget deficit is public dissavings

19­15


Government Saving
Federal Government (billions of dollars)
Receipts
Expenditures

2000
$2,057.1
1,871.9

State and Local Governments
Receipts

1,322.6

Expenditures

1,281.3

Federal Government (billions of dollars)
Receipts
Expenditures

2010
$2,385.2
3,718.7

State and Local Governments
Receipts

2,128.1

Expenditures

2,095.2
19­16


From Surplus to Deficit
•

Three reasons for change in U.S. government
budget
–

Government receipts decreased during the
recessions of 2001 and 2007-2009
•

–
–

Lower income during recession means lower taxes

Tax reductions during the first Bush term
Government spending increased
•
•

Wars in Iraq and Afghanistan
Homeland Security

19­17


U.S. National Saving, 1960-2010

19­18

Low Household Savings
•

National savings determines a country's ability to
invest in new capital goods
–
–
–

•

•

Household savings has been low
Business saving has been significant
In the 1990s, government saving increased

From 1960 to 2002, U.S. national saving rate
was fairly stable
Since 2002, U.S. government dissaving has
contributed to a decline in the U.S. national
saving rate
19­19


Three Reasons for Household
Saving
1.

Life-cycle saving is to meet long-term

objectives

–
–
2.

Precautionary saving is for protection against
setbacks
–

3.

Retirement
■ Purchase a home
Children's college attendance

Loss of job

■ Medical emergency

Bequest saving is to leave an inheritance
–

Mainly higher income groups
19­20


Household Saving in Japan
•

•

After World War II, household saving rates were
15 – 25%
– Declined after 1990
Life-cycle motives are important
–
–
–
–

•

Long life expectancy
Retire relatively early; long retirement period
Age structure of the population favored saving
Housing prices and down payment requirements were
very high
•
Property values decreased after 1990

Bequest savings matters; precautionary savings is
low
19­21


Saving and the
Real Interest Rate

•

Savings often take the form of financial assets
that pay a return
–
–
–

•

Interest-bearing checking ■ Bonds
Savings
■ CDs
Mutual funds
■ Stocks

The real interest rate (r) is the nominal interest
rate (i) minus the rate of inflation ( )
–
–

The increase in purchasing power from a financial
asset
Marginal benefit of the extra saving
19­22


Thrifts and Spends
•

Two otherwise identical families have different

savings rates
–

Higher savings reduces current consumption

Thrifts consume $32,000 in 1980 and Spends consume
$38,000
Spends
Thrifts
•
Thrifts get more
Savings
unearned income
5%
20%
Rage
Thrift's income grows Start Date
1980
1980
faster
End Date
2015
2015
– From 1995 on, Thrifts
Real Income
$40,000
$40,000
consume more than
Real Interest
8%

8%
•

•

Spends

19­23


Thrifts and Spends
•

By 2015
–
–

Spend’s consumption is $12,000 more than Thrift's
Retirement savings is $385,000
•

Spend's accumulated savings is $77,000

19­24


Savings in Perspective
•
•

•
•

•

8% is lower than the return to mutual funds since 1980
20% savings is higher than typical household
– Many have $5,000+ in credit card debt at high interest
rates
Bottom line: High savings rate pays off in the long run
If people are target savers, a high interest rate lowers
savings rate
– To get $25,000 in five years,
•
Save $4,309 per year at 5% OR
•
Save $3,723 per year at 10%
Data show higher real rates increase savings modestly
19­25