THE MEANING OF SAVING AND INVESTMENT

The terms saving and investment can sometimes be confusing. Most people use these terms casually and sometimes interchangeably. By ‘contrast, the macro economists who put together the national income accounts use these terms carefully and distinctly. Consider an example. Suppose that Larry earns more than he spends and deposits his unspent income in a bank or uses it to buy a bond or some stock from a corporation. Because Larry’s income exceeds his consumption, he adds to the nation’s saving. Larry might think of himself as “investing” his money, but a macro economist would call Larry’s act saving rather than investment In the language of macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings. When Moe borrows from the bank to build himself a new house, he adds to the nation’s investment. Similarly, when the Curly Corporation sells some stock and uses the proceeds to build a new factory, it also adds to the nation’s investment. Although the accounting identity S = I shows that saving and investment are equal for the economy as a whole, this does not have to be true for every individual household or firm, Larry’s saving can be greater than his investment, and he can deposit the excess in a bank. Moe’s saving can be less than his investment, and he can borrow the shortfall from a bank. Banks and other financial institutions make these individual differences between saving and investment possible by allowing one person’s saving to finance another person’s investment.

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