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Wize AP Macroeconomics Textbook > Saving, Investment and the Financial System

Government Budget and Debt

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Government Budget and National Saving


Paradox of Thrift

  • The paradox of thrift tells us that higher savings are
    bad
    in the short run (because lower spending and GDP) but
    good
    in the long run.
  • This is because if we save more money in the banks, they have more money to lend out to firms that can use that money to invest in capital goods (machines) that allow GDP to grow in the long run.

National Savings

The national savings are the private savings plus the public savings.
Private Savings = Y - C - T \boxed{\text{Private Savings = Y - C - T }}
Public Savings = T - G \boxed{\text{Public Savings = T - G }}


National Savings = (Y - T - C) + (T - G) \boxed{\text{National Savings = (Y - T - C) + (T - G) }}


National Savings (S) = Y - C - G \boxed{\text{National Savings (S) = Y - C - G }}


Example: If the national income is $1000, the consumption is $300, tax revenue is 400 and government expenditure is $250, what will the private, public and national savings be?

Private savings =
1000 - 300 - 400 = $300

Public savings =
400 - 250 = $150

National savings =
1000 - 300 - 250 = $450

  • Budget Surplus - when tax revenue is greater than government spending

  • Budget Deficit - when tax revenue is less than government spending

In a closed economy (no exports or imports) at equilibrium remember:

Y (Real GDP) = C + I + G \boxed{\text{Y (Real GDP) = C + I + G }}


and rearranging the above equation gives us:


Y - C - G = I \boxed{\text{Y - C - G = I }}

or :


National Savings (S) = Investment (I) \boxed{\text{National Savings (S) = Investment (I) }}




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Example: Paradox of Thrift


Accumulating capital:

a. allows society to consume more in the present
b. has no tradeoffs
c. requires society to sacrifice consumption goods in the present
d. decreases savings rates
e. both c and d


C.

When we save more, banks have more money to loan out to firms that spend it on capital (accumulation). To have higher savings means we have to spend less on consumption.

Practice: Paradox of Thrift


Governments can encourage growth and in the long run, raise their country's standard of living by encouraging:

Practice: National Savings


All else held constant, an increase in government spending would cause: