Chapter 24, Problem 1.1P

To determine

Saving and investment.

Explanation of Solution

Saving is that part of annual disposable income which is used by a consumer to be spent for future consumption. It can be formulized as $\left[\text{S=}\left(\text{Y}-\text{T}\right)-\text{C}\right]$. Investment is the value of planned plant purchases, equipment purchases and inventories purchase by business firms. Equilibrium occurs at the point when the Income equal to Aggregate expenditure which equals the sum of consumption, government spending and investment $\left(\text{Y=AE=C+I+G}\right)$ which can only occur if the leakages from circular flow (Savings (S) and Taxes (T)) are exactly matched by injections of demand (Investment (I) and Government spending (G)) i.e; $(\text{S+T=I+G)}$. If the saving is greater than taxes and investment equals government spending, then, $(\text{S+T>I+G)}$

If leakages surpass injections, the aggregate expenditure would be lower than aggregate output $\left(\text{C+S+T}\equiv \text{Y>C+I+G}\right)$ and as a result inventories will increase and the income (Y) will decline. Thus it will experience a recession.

If injections surpass leakages $\left(\text{G>T and S=I, S+T<I+G}\right)$,the aggregate expenditure would be higher than aggregate output  and as a result inventories will decrease and the income (Y) will increase.

Economics Concept Introduction

Concept introduction:

Saving: Saving is an income that is used by a consumer to spend for future consumption.