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Chapter 7

Chapter 7. Savings and Investment Process. © 2000 John Wiley & Sons, Inc. Chapter Outcomes. Identify and briefly describe the major components of the gross domestic product Describe how the balance between exports and imports affects the gross domestic product

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Chapter 7

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  1. Chapter 7 Savings and Investment Process © 2000 John Wiley & Sons, Inc.

  2. Chapter Outcomes • Identify and briefly describe the major components of the gross domestic product • Describe how the balance between exports and imports affects the gross domestic product • Discuss the link between gross private domestic investment and gross savings in the United States

  3. Chapter Outcomes(Continued) • Briefly describe the historical role of savings in the United States • Describe how financial assets and liabilities are created • Indicate the scope and magnitude of the federal budget and identify the principal sources of revenues and expenditures

  4. Chapter Outcomes(Concluded) • Explain the nature of federal government borrowing and describe recent trends in borrowing • Identify the major sources of savings in the United States • Explain how funds flow from savings into investments • Identify and describe the factors that affect savings

  5. Gross Domestic Product (GDP) and Capital Formation • GROSS DOMESTIC PRODUCT: GDP is a nation’s output of goods and services for a specified time • CAPITAL FORMATION: Process of constructing residential and nonresidential structures, manufacturing producers’ durable equipment, and increasing business inventories

  6. Gross Domestic Product (GDP) Components • EQUATION: GDP = PCE + GP + GPDI + NE • PERSONAL CONSUMPTION EXPENDITURES (PCE): Expenditures by individuals for durable goods, nondurable goods, and services • GOVERNMENT PURCHASES (GP): Purchases of goods and services by the government

  7. Gross Domestic Product (GDP) Components (Continued) • EQUATION: GDP = PCE + GP + GPDI + NE • GROSS PRIVATE DOMESTIC INVESTMENTS (GPDI): Investments in residential and nonresidential structures, producers’ durable equipment, and business inventories • NET EXPORTS (NE): Exports minus imports of goods and services

  8. Capital Consumption Allowances • CAPITAL CONSUMPTION ALLOWANCES DEFINED: Estimates of the “using up,” or depreciation of, plant and equipment assets for business purposes • IMPORTANCE: Capital consumption allowances represent the primary source of annual savings

  9. Creation of Financial Assets and Liabilities INDIVIDUALS Real Assets Financial Assets: Time Deposits Financial Liabilities Owners’ Equity COMMERCIAL BANK Real Assets Financial Assets: Business Loan Financial Liabilities: Time Deposits Owners’ Equity BUSINESS FIRM Real Assets Financial Assets Financial Liabilities: Business Loan Owners’ Equity

  10. Creation of Financial Assets and Liabilities • REAL ASSETS: Includes ownership of land, buildings, machinery, inventory, commodities, and precious metals • FINANCIAL ASSETS: Claims in the form of obligations or liabilities issued by individuals, businesses, financial intermediaries, and governments

  11. Economic Units: Savings Surplus Versus Savings Deficit • ECONOMIC UNIT: Governments, businesses, or individuals taken as a group • SAVINGS: Occurs when all of an economic unit’s income is not consumed but held in the form of cash and other financial assets

  12. Economic Units: Savings Surplus Versus Savings Deficit (Continued) • SAVINGS SURPLUS: Occurs when current income exceeds investment in real assets • SAVINGS DEFICIT: Occurs when investment in real assets exceeds current income • IMPORTANCE OF INDIVIDUALS: Individuals represent an important savings surplus economic unit

  13. Creation of Financial Assets and Liabilities • Process: --Individuals place their savings in time deposit accounts at a bank --The bank lends some of the deposits to a business firm

  14. Creation of Financial Assets and Liabilities (Continued) • Result: --Time deposits become financial assets of savers and financial liabilities to the bank --The business loan is a bank’s financial asset and the business firm’s financial liability

  15. Two Types of Financing • DIRECT FINANCING: Involves use of securities that represent specific contracts between the savers and borrowers themselves • INDIRECT FINANCING: Financing created by an intermediary that involves separate instruments with lenders and borrowers

  16. Federal Government Dollar:Fiscal Year 1999 • WHERE IT COMES FROM: --Individual income taxes (46%) --Social insurance receipts (34%) --Corporate income taxes (11%) --Excise taxes (4%) --Other (5%)

  17. Federal Government Dollar:Fiscal Year 1999 (Continued) • WHERE IT GOES: --Direct benefit payments for individuals (50%) --Grants to states and localities (15%) --National defense (15%) --Net interest (14%) --Other federal operations (5%) --Reserve pending social security reform (1%)

  18. Federal Budget Concepts • OFF-BUDGET OUTLAYS: Funding for some government agencies that is not included in the federal budget • BUDGETARY DEFICIT: Occurs when expenditures are greater than revenues • FEDERAL STATUTORY DEBT LIMITS: Limits on the federal debt set by Congress

  19. Two Types of Personal Savings • VOLUNTARY SAVINGS: Financial assets set aside for future use • CONTRACTUAL SAVINGS: Savings accumulated on a regular schedule by prior agreement (e.g., reserves in insurance and pension plans)

  20. Personal Savings in the U.S. • PERSONAL SAVINGS DEFINITION: Personal income Less: taxes and other payments Equals: disposable personal income Less: personal outlays Equals: personal savings • SAVINGS RATE DEFINITION: Savings Rate = (Personal Savings)/ (Disposable Personal Income)

  21. Types of Personal Savings • Cash balances • Time and savings deposits • Insurance reserves and pension funds • Securities

  22. Corporate Savings in the U.S. • UNDISTRIBUTED PROFITS DEFINITION: Profits before taxes Less: tax liabilities Equals: profits after taxes Less: dividends Equals: undistributed profits • RETENTION RATE DEFINITION: Retention Rate = (Undistributed Profits)/(Profits After Taxes)

  23. Lending in the Credit Markets: Financial Intermediation Sources • Commercial banks • Thrift institutions • Insurance and pension funds • Other financial intermediaries

  24. Sources of Funds Raised in the Credit Markets: By Borrowing Sector • U.S. government • State and local governments • Households • Farms • Nonfarm noncorporate • Corporate

  25. Sources of Funds Raised in the Credit Markets: By Instrument • U.S. government securities • Tax-exempt obligations • Corporate bonds • Mortgages • Consumer debt • Bank loans • Other debt

  26. Factors Affecting Savings • Levels of income • Economic expectations • Economic cycles • Life stages of the individual saver • Life stages of the corporation

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