Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

The ‘really long run’

Even though greater investment today can increase living standards in the future, macroeconomists think that the underlying level of investment is determined by the level of savings, which (rather confusingly) doesn’t depend on firms’ choices. What really matters is how much of national income is left

after consumers and the government have taken their portion. A little bit of maths is helpful here.

Assume a closed economy: one that doesn’t trade with the rest of the world (NX = 0). Total output (Y) must comprise consumption (C), investment (I) and government expenditure (G):

A simple rearrangement yields the following:

In other words, investment is what’s left over after consumption and government expenditure are taken away. To see why intuitively, think in terms of private saving and public saving. Private saving (S_PRI) is what private households have left after they pay for their consumption (C) and their taxes (T):

Public saving is any savings made by the government; it’s equal to tax revenue (T) less government expenditure (G):

That is, if the government receives more in taxes than it spends, public saving is positive. But if it spends more than it receives in taxes, public saving is negative (in other words, the government is having to borrow).

Therefore, total saving (S) is the sum of private and public saving:

which simplifies to

Notice that this is exactly equal to the expression for investment (


). Thus in a closed economy, savings must equal exactly investment:

because, in the long run, output (Y) is determined by the available factors of production and technology (see the earlier section ‘Testing your faith: Confidence in the economy’). The only way, really, of boosting investment is to have low levels of consumption (C) and/or low levels of government expenditure (G). For this reason, you hear economists sometimes say things like ‘government spending crowds out investment’. They mean that greater government spending lowers public saving, which lowers total saving, which lowers investment.