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Chapter 2(A). SAVING AND WEALTH. 3. SAVING AND WEALTH. Wealth Household wealth = a household’s assets minus its liabilities National wealth = sum of all households’, firms’, and governments’ wealth within the nation Saving by individuals, businesses, and government determine wealth.

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Chapter 2(A)

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Chapter 2 a

Chapter 2(A)

SAVING AND WEALTH


3 saving and wealth

3. SAVING AND WEALTH

  • Wealth

    • Household wealth = a household’s assets minus its liabilities

    • National wealth = sum of all households’, firms’, and governments’ wealth within the nation

    • Saving by individuals, businesses, and government determine wealth


Saving and wealth

SAVING AND WEALTH

AGG. SAVING

(+)

PRIVATE

SAVING

GOVT.

SAVING

(Spvt)

(Sgvt )

NATIONAL

SAVING

(S)


3 1 measures of aggregate saving

3.1 Measures of Aggregate Saving

  • Saving = current income – current spending

  • Saving rate = saving/current income

  • Private saving = private disposable income – consumption

    Spvt = (Y+NFP – T+TR+INT) – C …(2.6)


3 1 measures of aggregate saving1

3.1 Measures of Aggregate Saving

  • Measures of aggregate saving

    • Government saving = net government income – government purchases of goods and services

      Sgovt= (T – TR – INT) – G………………….(2.7)

      • Government saving = government budget surplus = government receipts – government outlays

      • Government receipts = tax revenue (T)

      • Government outlays = government purchases of goods and services (G) + transfers (TR) + interest payments on government debt (INT)


3 1 measures of aggregate saving2

3.1 Measures of Aggregate Saving

GOVT. SAVING

(BUDGET SURPLUS)

GOVT. RECEIPTS (T)

GOVT. OUTLAYS

minus

= TAX REVENUE

= Govt. purchases of goods & services (G) + Transfers (TR) + Int. payments on govt. debts (INT)


3 1 measures of aggregate saving3

3.1 Measures of Aggregate Saving

  • Government budget deficit = – Sgovt

  • Simplification: count government investment as government purchases, not investment


3 1 measures of aggregate saving4

3.1 Measures of Aggregate Saving

  • Measures of aggregate saving

    • National saving

      • National saving = private saving + government saving

      • S = Spvt + Sgovt …………………………… (2.8)

        = [Y + NFP – T + TR + INT – C]

        + [T – TR – INT – G]

        =Y+NFP – C – G= GNP – C – G


3 1 measures of aggregate saving5

3.1 Measures of Aggregate Saving

  • Uses of Private Saving

  • S = I + (NX + NFP) = I + CA

  • Derived from:

  • S = Y + NFP – C – G and

  • Y= C + I + G + NX

  • CA = NX + NFP = Current account

    balance


3 1 measures of aggregate saving6

3.1 Measures of Aggregate Saving

  • Uses of Private Saving

    • Spvt= I + (–Sgovt) + CA (2.11)

    • (using S = Spvt + Sgovt)

  • Saving is used in 3 ways

    • Investment (I)

    • Government Budget Deficit (-Sgovt)

    • Current Account Balance


3 2 wealth

3.2 WEALTH

  • Household Wealth = Assets – Liabilities

  • National Wealth = Sum of households’ wealth + firms’ + government wealth

  • Savings by individuals, businesses and government determine wealth.


3 3 relating saving and wealth

3.3 Relating Saving and Wealth

  • Stocks and flows

    • Flow variables: measured per unit of time (GDP, income, saving, investment)

    • Stock variables: measured at a point in time (quantity of money, value of houses, capital stock)

    • Flow variables often equal rates of change of stock variables

  • Wealth and saving as stock and flow (wealth is a stock, saving is a flow)


3 3 relating saving and wealth1

3.3 Relating Saving and Wealth

  • National wealth: domestic physical assets + net foreign assets

    • Country’s domestic physical assets (capital goods and land)

    • Country’s net foreign assets = foreign assets (foreign stocks, bonds, and capital goods owned by domestic residents) minus foreign liabilities (domestic stocks, bonds, and capital goods owned by foreigners)


3 3 relating saving and wealth2

3.3 Relating Saving and Wealth

  • Changes in national wealth are a change in the value of existing assets and liabilities.

  • National Saving raises wealth.

  • Wealth matters because the economic well-being of a country depends on it


  • 3 3 relating saving and wealth3

    3.3 Relating Saving and Wealth


    3 3 relating saving and wealth4

    3.3 Relating Saving and Wealth

    • Application: Wealth Versus Saving

      • We might not need to worry about the decline in the personal saving rate because:

        • private saving is the relevant measure of saving

        • the personal saving rate may be revised upward in the future

        • the personal saving rate ignores capital gains; as people’s wealth rises, their saving rate declines


    4 real gdp price indexes and inflation

    4.REAL GDP, PRICE INDEXES ANDINFLATION

    • Real GDP

      • Nominal variables are those in dollar terms

      • Problem: Do changes in nominal values reflect changes in prices or quantities?

      • Real variables: adjust for price changes; reflect only quantity changes


    4 1 real versus nominal gdp

    4.1 Real versus nominal GDP

    • The output of a company or the entire economy can be expressed in real or nominal terms.

    • Nominal GDP

    • Also called current-dollar GDP. It is the dollar value of an economy’s final output measured at current market prices.


    4 1 real versus nominal gdp1

    4.1 Real versus nominal GDP

    • Real GDP

      • Example : of computers and bicycles

      • Nominal GDP is the dollar value of an economy’s final output measured at current market prices

      • Real GDP is an estimate of the value of an economy’s final output, adjusting for changes in the overall price level


    4 1 real versus nominal gdp2

    4.1 Real versus nominal GDP

    • Real GDP

    • Also known as constant-dollar GDP. It is the measure of the physical volume of an economy’s final production.

    • Real GDP = Nominal GDP

    • GDP deflator


    4 1 real versus nominal gdp3

    4.1 Real versus nominal GDP

    Methods for breaking changes in nominal variables into part owing to physical quantities and part owing to changes in prices.


    4 2 calculation of real output with alternative base years

    4.2 Calculation of Real Output with Alternative Base Years

    • How much increase in nominal output is attributable to an increase in physical output?

    • Simple way to remove the effect of the price changes, we focus on the quantity changes of the output .

    • This can be done by measuring the value of production in each year by using prices from some base year.


    4 2 calculation of real output with alternative base years1

    4.2 Calculation of Real Output with Alternative Base Years


    4 3 price indexes

    4.3 Price Indexes

    • Price index measures the average level of prices for some specific set of goods and services, relative to the prices in a specified base year.

    • GDP deflator – is a price index that measures the average level prices of good and services included in GDP.

    •  GDP deflator = 100 x nominal GDP/real GDP

    • Note: For base year, Price (P) = 100


    4 3 price indexes1

    4.3 Price Indexes

    • Price Indexes

      • Consumer Price Index (CPI)

        • Monthly index of consumer prices;

        • index averages 100 in reference base period (1982 to 1984)

        • Based on basket of goods in expenditure base period (2003 to 2004)

      • Need for base year to revised frequently.


    4 3 price indexes2

    4.3 Price Indexes

    • Price Indexes

      • Box 2.2 on the computer revolution and chain-weighted GDP

        • Choice of expenditure base period matters for GDP when prices and quantities of a good, such as computers, are changing rapidly

        • BEA compromised by developing chain-weighted GDP

        • Now, however, components of real GDP don’t add up to real GDP, but discrepancy is usually small


    4 4 inflation

    4.4 Inflation

    • An important variable that is measured with price index is the rate of inflation.

    • In general terms, to calculate inflation rate:

      t+1= (Pt+1 – Pt)/Pt = Pt+1/Pt

    • t + 1 = rate of inflation

    • Pt = price level period t

    • Pt +1 = price level period t +1


    4 4 inflation1

    4.4 Inflation

    • Box 2.3: Does CPI inflation overstate increases in the cost of living?

      • The Boskin Commission reported that the CPI was biased upwards by as much as one to two percentage points per year

      • One problem is that adjusting the price measures for changes in the quality of goods is very difficult


    4 4 inflation2

    4.4 Inflation

    • Price Indexes

    • Box 2.3: Does CPI inflation overstate increases in the cost of living?

      • Price indexes with fixed sets of goods don’t reflect substitution by consumers when one good becomes relatively cheaper than another

        • This problem is known as substitution bias


    4 4 inflation3

    4.4 Inflation

    • Price Indexes

    • Box 2.3: Does CPI inflation overstate increases in the cost of living?

      • If inflation is overstated, then real incomes are higher than we thought and we’ve overindexed payments like Social Security

      • Latest research (July 2006) suggests bias is still 1% per


    4 5 interest rate

    4.5 Interest rate

    • Real vs. nominal interest rates

    • A rate of return promised by a borrower to a lender.

    • An interest rate indicates how quickly a nominal, or dollar, value of an interest bearing assets increases over time but it does not reveal how quickly the value of the asset changes in real or purchasing-power terms.


    4 5 interest rate1

    4.5 Interest rate

    • Real vs. nominal interest rates

    • Real interest rate (r): the real rate of return or purchasing power of the assets increases over time.

    • Nominal interest rate (): rate at which the nominal value of an asset increase over time


    4 5 interest rate2

    4.5 Interest rate

    • Real vs. nominal interest rates

    • Real interest rate

    • =Nominal interest rate – Inflation rate

    • r = i - 


    4 5 interest rate3

    4.5 Interest rate

    • Real vs. nominal interest rates

    • Expected real interest rate

    • =Nominal interest rate – expected rate of inflation

    • r = i - e

    • The expected interest real interest rate is the correct interest rate to use for studying most types of economic decision.

    • If  = e, real interest rate = expected real interest rate


    4 5 interest rate4

    4.5 Interest rate

    • Real vs. nominal interest rates

      • Interest rate: a rate of return promised by a borrower to a lender

      • Real interest rate: rate at which the real value of an asset increases over time

      • Nominal interest rate: rate at which the nominal value of an asset increases over time


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