Lecture 5

Saving-Investment and Financial system

◼ References:
◼ N. Gregory Mankiw, “Principles of Economics”,
chapters 26-27
◼ NEU, “Economics”, chapters 16

August 2022 1
Content

1. Investment and Saving

2. Financial Intermediaries
3. Stock and Bond markets
4. Policies to encourage saving and investment

2
 The Macroeconomic Circular Flows
X IM
Revenue TR Consumption C
Market for final goods
Sell goods- and services Buy goods-
services services
I
G S

Firms Government Households

Te Td
tax direct

Yd = Y - Td

Inputs for Prod. Market for K, L, R, T

production factors
Prod. Cost Income Y
3
 Definition:
◼ Saving
◼ is the rest of disposable income that is not consumed
◼ is lent in the financial system

◼ YD = C + S → S = (Y-T) – C
SAVING PRIVATE
◼ Y: income
◼ YD: disposable income
◼ T: net tax (Tax – Income transfers)
◼ C: consumption
◼ S: saving
4
Definition:
◼ Investment is the purchase of equipment
and structures in the production of goods
and services

◼ Including:
◼ Machinery, equipment and structures
◼ Inventories
◼ New houses
5
Relationship of Saving and
Investment T-G= BB Budget balance
T-G= SG = goverment saving

Macroeconomic Identity for close economy:

Total Income = Total Expenditures - Te
➔ YIncome = YExpenditure - Te = C + I + G - Te

➔ Td + C + S = C + I + G - Te Te: thuế
➔ S – I + T – G = 0 C,S: Disposable income

➔ SP + SG = I

➔ SN =I

6
 Relationship of Saving and
Sp: private saving
Investment Sg: goverment saving
Sn: national saving
sources for
Investment:
1. Sp
2. Sg
◼ SN = SP + SG = I → SG = I - SP
◼ If there is a deficit of government budget SG < 0 then
◼ SP – I >0 : the government needs to borrow from private
sector to spend Sp cho chính phủ vay để bù đắp thâm hụt

◼ If there is a surplus of government budget SG>0 then

◼ SP – I <0 : the private investment is partly financed by the
surplus from government budget
Sp= -Sg+ I
◼ Other conclusions
7
Exercise 4 (p.574)
◼ Suppose GDP is $8 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.

8
 Relationship of Saving and
Investment

Saving The Financial System Investment

Disposable •Production lines

Income •Machinery
Minus •Plant, structures
Consumption •Inventories
•New houses
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 The financial system

Directly

Saving Investment

Intermediaries
Commercial Financial Financial Insurance
bank Funds company company

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 Saving and Investment in the
Financial System
The Bond market
And
The Stock Market

Saving Investment

Commercial Bank
Income •Machinery
minus •Plant
Consumption Mutual Fund •Structures

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The financial intermediaries

◼ Commercial Bank
◼ Mutual Fund/Financial Fund

12
 The Financial System

Money Directly Bonds

Stocks

Saving Investment

Disposable •Production line

Income Intermediaries •equipment
Minus •Structures
Consumption •Inventories
•New House 13
 The Bond market
◼ Bonds:
is the certificate of indebtedness that specifies the obligation
of the borrower to the holder of the bond
◼ Characteristics:
◼ Borrowers: government, firm, bank… → legal agents

◼ Principal

◼ Interest rate fixed by

➢ Bonds’ term / Date of maturity

➢ Credit risks
➢ Tax treatment
◼ Name or not 14
An example of government bond

15
 ABC enterprise (state-own or private)
◼ In order to issue stocks → become Joint Stock Company → via
equitisation/privatisation
◼ VND 30 bln : 10k/stocks = 3 mln stocks → owned by A, B, C
◼ A’s share is 50% → 15 bln → 1.5 mln stocks
◼ B’s share is 20% → 6 bln → 0.6 mln stocks
◼ C’s share is 30% → 9 bln → 0.9 mln stocks
◼ 1 stock = 10k → 30 bln = 3 mln stocks
◼ ABC’s stock price = 15k
→ VND 45 bln → owned by A, B, C
◼ A’s share is 50% → 1.5 mln stocks → 22.5 bln
◼ B’s share is 20% → 0.6 mln stocks → 9 bln
◼ D’s share is 30% → 0.9 mln stocks → 13.5 bln (C’s stocks is transferred
to D) 16
 ABC enterprise (state-own or private)
◼ Issue stocks to increase/ raise fund: 30 bln
◼ 1 stock = 20k → 30 bln = 1,5 mln stocks issued
◼ 1.5 mln stocks → 30 bln → A’s share is 33.3%
◼ 0.6 mln stocks → 12 bln → B’s share is 13.3%
◼ 0.9 mln stocks → 18 bln → D’s share is 20%
◼ 1.5 mln stocks → E’s share is 33.3%
◼ 1 stock = 30k → 30 bln = 1 mln stocks issued
◼ 1.5 mln stocks → 45 bln → A’s share is 37.5%
◼ 0.6 mln stocks → 18 bln → B’s share is 15%
◼ 0.9 mln stocks → 27 bln → D’s share is 22.5%
◼ 1 mln stocks → E’s share is 25% 17
 The Stock Market
◼ Stock/Equity:
represents ownership in a firm and is, therefore, a
claim to the profits that the firm makes
◼ Characteristics:
◼ Only Joint Stock Company (JSC.)
◼ Stock holder is the owner of the firm
◼ No interest rate
◼ No maturity
18
The Bond Market and Stock Market
◼ Stock seems to be more profitable
compared with bond, because of:
◼ Longer time
◼ More risky
◼ Ownership vs. Borrowing

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 Market for loanable funds

Stocks

Bonds

Saving Investment
Commercial banks

Mutual funds

Supply of funds Demand for funds

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 Market for loanable funds
Real Supply
◼ SUPPLY Interest rate S = S P + SG
◼ SN = SP + SG B
r1
◼ r → SP → movement
along supply curve A C
r0
◼ T, G, Y… → SN →
supply curve shift
left/right
SN=Q0 SN’=Q1 Quantity
of funds
21
 Market for loanable funds
Real
◼ DEMAND Interest rate
◼ Investment
◼ r → cost for borrowing
→ movement along A C
r0
demand curve
r1 B
◼ expectation, policies…
Demand
→ I → demand curve I
shift left/right
Q0 Quantity
of funds
22
 Market for loanable funds
Real Supply
◼ Equilibrium Interest rate SN = S P + S G
◼ Interest rate r0
◼ Quantity at equilibrium is

the quantity of funds that is

transferred from saver to r0
borrower → increase investment
→ increase the stock of capital
S = I = Q0 Demand
I
◼ If S=I=Q1>Q0 → K?
◼ If S=I=Q2<Q0 → K? Quantity
Q0
of funds
23
 Market for loanable funds
Real Supply
◼ A change in saving Interest rate SN = S P + S G
◼ Shift supply of funds
◼ New equilibrium

Higher Q → higher investment

r0
→ increase K more

◼ If S=I=Q1>Q0 → K?
◼ If S=I=Q2<Q0 → K? Demand
I

Q0 Quantity
of funds
24
 Market for loanable funds
Real
Interest rate Supply
◼ A change in Investment SN = S P + S G
◼ Shift Demand for funds
◼ New equilibrium

Lower Q → increase investment

r0
but less→ increase K but less

◼ If S=I=Q1>Q0 → K?
◼ If S=I=Q2<Q0 → K? Demand
I

Q0 Quantity
of funds
25
 Market for loanable funds
Real Supply
Interest rate S = S P + SG

r0 r0

Demand
I

Q0-20 Quantity Q0-20 Q0 Quantity

Q0
of funds of funds
26
 Market for loanable funds
Real Supply
Interest rate S = S P + SG

r0 r0

Demand
I

Q0-20 Quantity Q0-20 Q0 Quantity

Q0
of funds of funds
27
 4. Policies to encourage S-I
Real Supply
◼ Policy 1 Interest rate SN = S P + S G
◼ Incentive to private saving
◼ …

r0

Demand
I

Q0 Quantity
of funds
28
 4. Policies to encourage S-I
Real Supply
◼ Policy 2 Interest rate SN = S P + S G
◼ Incentive to private
investment
◼ …
r0

Demand
I

Q0 Quantity
of funds
29
 4. Policies to encourage S-I
Real Supply
◼ Policy 3 Interest rate SN = S P + S G
◼ Government spending
◼ Tax
◼ …
r0

Demand
I

Q0 Quantity
of funds
30
 4. Policies to encourage S-I
◼ Effects of Policy 1 Real Supply
◼ …→ Sp increases Interest rate SN = S P + S G
→ Sn increases
→ supply shifts right S’
→ surplus of supply
→ r decreases → movements along r0 A B
demand (I increases), supply (Sp
r1
decreases) C
→ Conclusion: Sp increases = Sn Demand
increases = I increases I
◼ Elasticity of supply should be less
Q2
and/or elasticity of demand should Q0 Q1 Quantity
be more to increase the effect of of funds
31
this policy on S-I