Keynesian Saving = Investment Equilibrium

            Investigating how investment and saving are related provides another view of how National Income and Output are determined. Inspection of Table 1 and Figure 1 reveals that a stable equilibrium requires planned levels of saving and investment to be equal.

Actual and planned saving and investment are all equal (S = I) in a macroequilibrium in a private economy without government or foreign trade.

FIGURE 1   Keynesian Equilibrium

Table 1     Levels of Income, Employment, and Output  (billions of dollars)
(1) Employment (millions of workers)	(2) National Output & Income	(3)   Planned Consumption	(4)   Planned Saving	(5)   Planned Investment	(6) Unplanned Inventory Changes	(7) AE =Aggregate Expenditures (columns 3 + 5)
100.00	$5,000	$   5,100	$-100	$ 300	$ -400	$ 5,400
105.00	5500	5500	0.00	300.00	-300.00	5800
110.00	6000	5900	100.00	300.00	-200.00	6200
115.00	6500	6300	200.00	300.00	-100.00	6600
120.00	7,000	6700	300.00	300.00	- 0 -	7000	equilibrium
125.00	7500	7100	400.00	300.00	100.00	7400
130.00	8000	7500	500.00	300.00	200.00	7800
135.00	8500	7900	600.00	300.00	300.00	8,200

Households' saving plans and firms' investment plans must both be realized for equilibrium to occur, regardless of whether the model used is Keynesian or classical.

 

Planned Saving and Investment

            Study columns 4 and 5 in Table 1, which are graphed in Figure 2. In our simple model, firms plan to invest $300 billion regardless of national income, while consumers' saving is tied to income. Suppose income were $8,500 billion. Consumers would try to save $600 billion (point f in Figure 2), but investment plans absorb only $300 billion (point g). What will be the result?

 

FIGURE 2  Equilibrium Saving and Investment

Macroequilibrium is achieved when plans for saving and investment are in balance. If income falls below equilibrium (point e = $7,000 billion), business inventories decline below desired levels. When income exceeds equilibrium, business accumulates undesired inventories and, consequently, cuts production to bring inventories back in line. Only at equilibrium are desired saving and desired investment equal.

 

            Saving is the act of not consuming. Because income saved is money not spent, saving is a withdrawal of funds from the system.

Withdrawals occur when income is not spent on domestic output.

            In addition to saving, withdrawals include taxes (income paid to the government) and imports (most foreign income is spent in the recipients' own countries). Because spending is perceived to drive a capitalist system, withdrawals tend to stifle income creation in this simple Keynesian model.

            Injections are the reverse of withdrawals; they reflect new sources of spending.

Autonomous spending (regardless of source) represents an injection into the Keynesian spending stream.

 

We will discuss the effects of injections on National Income after we consider the consequences of such forms of withdrawals as household saving.

 

            Excess saving causes unwanted inventories to pile up—output exceeds sales because withdrawals create excess supplies of most goods. Firms will find total consumer and business spending (C + I) insufficient to clear new output from the market. Production and employment will fall because firms do not desire these investments in inventory. Income drops as the economy moves back from points f and g toward equilibrium at point e, where planned saving and planned investment are equal. Planned and realized saving and investment are all equated, and income stops falling as equilibrium is approached.

 

            These adjustments reverse direction if output is below the $7,000 billion equilibrium level. For example, when National Output is $6,500 billion, consumers desire to save $200 billion and spend $6,300 billion, while firms plan to invest $300 billion; Aggregate Expenditures (C + I) equal $6,600 billion. The $100 billion shortfall of goods to accommodate buyers shrinks inventories, which fall by an unplanned $100 billion in each period. Production then expands to restore inventories to desired levels. Income rises to $7,000 billion (from c and d in Figure 2 to point e) before inventories become stable; planned saving and investment both equal $300 billion at point e. Thus, equilibrium requires planned saving to equal planned investment (S = I).

 

 

Balancing Planned and Actual Saving and Investment

 

            Inventory fluctuations, whether planned or unexpected by managers, ensure the constant equality of actual saving and investment. Unplanned investment, which equals changes in inventories, also help align investors' plans with those of savers by serving as business barometers. Unexpectedly brisk sales are great news for business, but inventories then unintentionally shrink. Firms adjust by boosting output. However, when weak sales fail to match forecasts, inventories swell and firms cut output and employment to correspond with households plans to spend less and save more.

 

            Several mechanisms, including inventory changes, aid in managerial decisions designed to equate planned saving and investment. Empty shelves and rainchecks become common during shortages, when consumers cannot buy all the goods they demand. Queues and shortages also signal firms to expand productive capacity or, perhaps, to raise prices.

 

            Keynesian models presuppose idle productive capacity, so quantity adjustments clear the market—output and employment adjust to eliminate disparities between Aggregate Spending and National Output. Classical reasoning posits full employment, with all markets clearing through wage and price adjustments. Both theories agree, however, that only when planned investment exactly equals planned saving will a private economy attain equilibrium. When households' plans to save and firms' plans to invest are both realized, sales precisely sustain equilibrium output with no net pressure for growth or stagnation. .