Chapter 7

Savings and Investment Savings and Investment ProcessProcess

© 2000 John Wiley & Sons, Inc.

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Chapter Outcomes

Identify and briefly describe the major components of the gross domestic product

Describe how the balance between exports and imports affects the gross domestic product

Discuss the link between gross private domestic investment and gross savings in the United States

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Chapter Outcomes(Continued)

Briefly describe the historical role of savings in the United States

Describe how financial assets and liabilities are created

Indicate the scope and magnitude of the federal budget and identify the principal sources of revenues and expenditures

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Chapter Outcomes(Concluded)

Explain the nature of federal government borrowing and describe recent trends in borrowing

Identify the major sources of savings in the United States

Explain how funds flow from savings into investments

Identify and describe the factors that affect savings

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Gross Domestic Product (GDP) and Capital Formation

GROSS DOMESTIC PRODUCT:GROSS DOMESTIC PRODUCT: GDP is a nation’s output of goods and services for a specified time

CAPITAL FORMATION:CAPITAL FORMATION: Process of constructing residential and nonresidential structures, manufacturing producers’ durable equipment, and increasing business inventories

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Gross Domestic Product (GDP) Components

EQUATION:EQUATION: GDP = PCE + GP + GPDI + NE

PERSONAL CONSUMPTION PERSONAL CONSUMPTION EXPENDITURES (PCE):EXPENDITURES (PCE): Expenditures by individuals for durable goods, nondurable goods, and services

GOVERNMENT PURCHASES (GP):GOVERNMENT PURCHASES (GP): Purchases of goods and services by the government

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Gross Domestic Product (GDP) Components (Continued)

EQUATION:EQUATION: GDP = PCE + GP + GPDI + NE

GROSS PRIVATE DOMESTIC GROSS PRIVATE DOMESTIC INVESTMENTS (GPDI):INVESTMENTS (GPDI): Investments in residential and nonresidential structures, producers’ durable equipment, and business inventories

NET EXPORTS (NE):NET EXPORTS (NE): Exports minus imports of goods and services

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Capital Consumption Allowances

CAPITAL CONSUMPTION ALLOWANCES DEFINED: Estimates of the “using up,” or depreciation of, plant and equipment assets for business purposes

IMPORTANCE: Capital consumption allowances represent the primary source of annual savings

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Creation of Financial Assets and Liabilities

INDIVIDUALS

COMMERCIAL BANK

BUSINESS FIRM

Real Assets

Financial Assets: Time Deposits

Financial Liabilities

Owners’ Equity

Real Assets

Financial Assets: Business Loan

Financial Liabilities:Time Deposits

Owners’ Equity

Real Assets

Financial Assets

Financial Liabilities:Business Loan

Owners’ Equity

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Creation of Financial Assets and Liabilities

REAL ASSETS: Includes ownership of land, buildings, machinery, inventory, commodities, and precious metals

FINANCIAL ASSETS: Claims in the form of obligations or liabilities issued by individuals, businesses, financial intermediaries, and governments

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Economic Units: Savings Surplus Versus Savings Deficit

ECONOMIC UNIT: Governments, businesses, or individuals taken as a group

SAVINGS: Occurs when all of an economic unit’s income is not consumed but held in the form of cash and other financial assets

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Economic Units: Savings Surplus Versus Savings Deficit

(Continued) SAVINGS SURPLUS:

Occurs when current income exceeds investment in real assets

SAVINGS DEFICIT: Occurs when investment in real assets exceeds current income

IMPORTANCE OF INDIVIDUALS: Individuals represent an important savings surplus economic unit

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Creation of Financial Assets and Liabilities

Process:

--Individuals place their savings in time deposit accounts at a bank

--The bank lends some of the deposits to a business firm

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Creation of Financial Assets and Liabilities (Continued)

Result:

--Time deposits become financial assets of savers and financial liabilities to the bank

--The business loan is a bank’s financial asset and the business firm’s financial liability

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Two Types of Financing

DIRECT FINANCING: Involves use of securities that represent specific contracts between the savers and borrowers themselves

INDIRECT FINANCING: Financing created by an intermediary that involves separate instruments with lenders and borrowers

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Federal Government Dollar:Fiscal Year 1999

WHERE IT COMES FROM:

--Individual income taxes (46%)

--Social insurance receipts (34%)

--Corporate income taxes (11%)

--Excise taxes (4%)

--Other (5%)

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Federal Government Dollar:Fiscal Year 1999 (Continued)

WHERE IT GOES:

--Direct benefit payments for individuals (50%)

--Grants to states and localities (15%)

--National defense (15%)

--Net interest (14%)

--Other federal operations (5%)

--Reserve pending social security reform (1%)

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Federal Budget Concepts OFF-BUDGET OUTLAYS:

Funding for some government agencies that is not included in the federal budget

BUDGETARY DEFICIT: Occurs when expenditures are greater than revenues

FEDERAL STATUTORY DEBT LIMITS: Limits on the federal debt set by Congress

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Two Types of Personal Savings

VOLUNTARY SAVINGS:VOLUNTARY SAVINGS: Financial assets set aside for future use

CONTRACTUAL SAVINGS:CONTRACTUAL SAVINGS: Savings accumulated on a regular schedule by prior agreement (e.g., reserves in insurance and pension plans)

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Personal Savings in the U.S.

PERSONAL SAVINGS DEFINITION:PERSONAL SAVINGS DEFINITION: Personal income Less: taxes and other payments Equals: disposable personal income Less: personal outlays Equals: personal savings

SAVINGS RATE DEFINITION:SAVINGS RATE DEFINITION: Savings Rate = (Personal Savings)/ (Disposable Personal Income)

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Types of Personal Savings

Cash balances Time and savings deposits Insurance reserves and pension

funds Securities

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Corporate Savings in the U.S.

UNDISTRIBUTED PROFITS DEFINITION: Profits before taxes Less: tax liabilities Equals: profits after taxes Less: dividends Equals: undistributed profits

RETENTION RATE DEFINITION: Retention Rate = (Undistributed Profits)/(Profits After Taxes)

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Lending in the Credit Markets: Financial Intermediation Sources

Commercial banks Thrift institutions Insurance and pension funds Other financial intermediaries

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Sources of Funds Raised in the Credit Markets:

By Borrowing Sector U.S. government State and local governments Households Farms Nonfarm noncorporate Corporate

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Sources of Funds Raised in the Credit Markets: By Instrument

U.S. government securities Tax-exempt obligations Corporate bonds Mortgages Consumer debt Bank loans Other debt

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Factors Affecting Savings

Levels of income Economic expectations Economic cycles Life stages of the individual saver Life stages of the corporation