The first part of this lecture covers the relationship between

two variables that are crucial to understand growth in the

long run: savings and investment. In the previous lecture, we
have seen that capital stock is an important determinant of
productivity and income per capita
and that the flow of physical investment accumulates in the
stock of physical capital. Hence, the determinants of investment
are crucial to understand the variability of incomes
and standards of living across countries.
One way to start the analysis of savings and investment is
to use our framework of the National Accounts with the four
sectors mentioned in Unit One: households, firms,
public sector, and foreign sector. We will assume for now that we are
in a closed economy. A country with a closed economy is a country
that has no economic transaction with any other country;
in this context exports and imports are zero
and we can simplify the model to have only households,
firms and the public sector. We will relax this assumption in Unit
four, where we will introduce explicitly in our model the capital
flows between the interior sector and the foreign sector.
If we put together firms and households we get what we call
the private sector. And the other sector of interior economy is the public sector.
Given that we have only the private sector and the public sector,
total national savings must be originated in either of these sectors.
To understand how total savings are defined we introduce
here three new variables: first, taxes, denominated by capital t (T)
which is equal to the total amount of resources that the sector,
that the public sector gets from the private sector.
Second, disposable income denominated by capital y sub d (Yd).
And third, private savings, denominated by capital s sub
pr (Spr). The disposable income of the private sector is equal to
the total income of the economy (Y) minus taxes (T).
This disposable income is used either to consume or to save.
So, private savings are equal to total income minus taxes minus
consumption. Given that we are working in the context of national
accounts, the variables income and consumption are the same
that we have defined in Unit One. Hence, some variables used
to define "private savings" are the same variables that we use in
our analysis of national accounts. The private sector saves
that part of the total income that is neither used to pay taxes
nor consumed. Let's now consider the public sector.
We define a new variable called Public Savings denominated by capital
s sub pu (Spu). The revenue of the government is equal
to the taxes it collects from the private sector
(T) and these resources are used either to purchase goods
and services (G) or to save. So, public savings are equal
to taxes minus the government purchases of goods and services.
From the previous slides, we have said that national savings
come from either the public or the private sector (remember that we are assuming
a closed economy). Hence, we can define national
savings as the sum of private and public savings.
On the one hand, private savings are equal to national income
minus taxes minus private consumption. On the other hand,
public savings are equal to taxes minus the public purchases
of goods and services. Combining the three expressions and simplifying
T we get that national savings are equal to national income
minus private consumption minus the public purchases of goods
and services. We can also remember from Lecture one that national
income is equal to private consumption plus investment plus
government purchases of goods and services
plus net exports. In a closed economy net exports are zero
and, therefore, investment is equal to national income
minus private consumption minus government purchases.
Combining the results we have that in a closed economy national
savings are equal to investment. The identity between savings and
investment in a closed economy says something quite important:
the expansion of the productive capacity of a economy
depends on the decisions of not consuming today
and producing goods that can be used to produce other goods
in the future (investment goods). In Unit four we will see that
in an open economy, investment can also be expanded with
the inflow of foreign investment. A last explanation in this video
is to answer a question: what if the amount that firms and households
want to invest is smaller than the amount that households and the
government want to save? The key to answer this question is in the
concepts of non-desired investment and the increase in inventories.
if households and the public sector want to increase savings, they
will consume less, firms will sell less and they will accumulate
large inventories that are considered non-desired investment.
Do you remember that in Unit one we have said that
all the production that is not sold is regarded investment?
So, the link between changes in consumption and changes in non-desired
investment is what makes the identity "S equals I"
to be always true. Next we are going to disentangle how markets
connect the savings of one particular agent with the investment
of another. This is done in what we call the market of loanable funds,
the topic of our next video.