Basic Economics Question

[Deinonychus_antirhoppus]

I have am somewhat interested in testing a hypothesis, and answering the following question will help.

Does and increase in savings help promote economic growth or reduce it? Please try to explain your answer.

[VRWCmember]

Under the Equilibrium Income Model, an increase in savings leads to a decline in national income -- a phenomenon called the Paradox of Thrift.

The basis of this model is that on the income side you have consumption + savings and on the expenditure side you have production (for consumption) and investment. (Actual Investment includes inventory). As long as savings is equal to or less than intended investment, the economy will be at equilibrium or growing. The reason for this is that if savings is equal to or less than intended investment, then consumption spending is equal to or greater than planned production of consumption goods. As a result, inventories (part of actual investment) become depleted and producers will increase production (requiring additional labor and investment) leading to increased national income.

Here's where the Paradox of Thrift comes in: If savings is greater than intended investment, then consumption spending is less than production of consumption goods. As a result, actual investment exceeds intended investment and inventories accumulate. In this condition of excess inventories, producers reduce output, reduce the employment of labor resources and thus national income decreases.

This nutshell presentation of the Equilibrium Income model may be difficult to fully grasp if you are not already familiar with the Aggregate Demand and Aggregate Supply model, the Expenditure and Income Components of Aggregate Demand and how these components make up the GDP, etc. I hope it was helpful.

[uncitizen]

More money in savings accounts means the banks have more money to lend. The borrowers of that money will presumably spend it on something or invest it.

[sharktrager]

Actually, savings would not have that impact.

Money which is not saved is either spent or invested. In either case, 100% of the funds are placed in to circulation. However, a bank is only allowed to lend a percentage of what they have on deposit. As a result, less than 100% of money in savings is then spent or invested..

[Tijeras_Slim]

You spelled antirrhopus wrong.

[Deinonychus_antirhoppus]

Yeah, tell me about it...my stupid fingers. Pardon me while I smash them in a drawer...*sigh*

Thanks for the response folks, and if anybody else wants to chime in, please feel free.

[Tijeras_Slim]

Don't worry... there's a number of posters here with misspelled screenames. Many of them revered and distinguished. Welcome to FR.

[rwfok]

http://deinonychus.blogspot.com/

I don't read DU. Did they have even the faintest clue?

[Deinonychus_antirhoppus]

Well, I see you found me out. Yes that is my blog, and yes that top post has the reason why I asked my question. My hunch was that most people here wouldn't see savings automatically as a bad thing. Over at DU, there are a couple of threads where posters make such claims.

Democratic Underground has provided the grist for many, many blog posts.

[rwfok]

Hardly a fair question to ask the poor folks at DU. Next time, keep the queries limited to organic farming and pharmaceuticals if you hope to receive coherent answers. ;)

[VRWCmember]

Some alternative (and IMHO better) Basic Economics questions could have been:

1. Are reductions in tax rates "Demand-Side" (Keynesian) Economic Stimulants or "Supply-Side" Economic Stimulants? Why?

(The correct answer, of course, is that reductions in tax rates stimulate demand [through increased consumption] in the short run and stimulate supply [through increased investment] in the long run.)

2. How do increases in the minimum wage affect employment and overall income?

3. How is economic growth measured and what defines a recession and a recovery? When did the last two recessions and their subsequent recoveries begin?

[Deinonychus_antirhoppus]

Oh now that last one on recessions is just not fair. Nobody at DU (save for RogerAshton--and actual economist) would know that or where to look. I have seen various posters set the date the previous recession ended well into 1993...nothing like being off 1 1/2-2 years.

I have watched numerous threads there on economics and frankly its....sad, very sad.

[spqrzilla9]

Did you know that you are a very mean person?

[Deinonychus_antirhoppus]

Yes.

[Temujin]

C+I+G+(ex-Im) = GDP. Aggregate Demand.

Increasing I , investment, will increase GPD. This is the aggregate expendatures model of caluculation GPD using the Aggregate supply/aggregate demand graph.

It is MacroEco 101.

To try to increase investment , the government can embark on Expansionary Monetary or Fiscal policy. Expansionary monetary policy has to do woth Fed Expansions of the money supply. Expansionary Fiscal Policy has to do with ether the government spending monmey or cutting taxes, or , of cource, both.

[bruinbirdman]

As a result, less than 100% of money in savings is then spent or invested..

I don't think that is the case. Suppose I save $1000 and put it in the bank. The bank must reserve 6% ($60) in case someone wants to make a withdrawal. The bank can then loan $940.

You borrow $940 from the bank for home improvements but can only use $140 this month. You deposit $800 in your bank account until you need it. The bank now has another $800 of deposits. It reserves 6% as required by law and lends $752.

As you can see, if the reserve rate is 6%, the bank can theoretically lend about 16 times the amount.

yitbos

[sharktrager]

That is called the money multiplier. Funds spent or invested do the exact same thing, but the initial amount does not have the 6% reserve. As this compounds, the difference is substantial