Savings and Investment Central Formulas in Economics Report

Economy is the science dealing with numerous formulas and equations that allow people monitor the development of the human societies and separate organizations within it. The terms like private, public, and national saving, investment, and equilibrium real interest rate are central to economy.

The calculation of the private saving (PrS) of Ecoland can thus be carried out on the basis of the formula that extracts consumption (C) from the total disposable income (Y – T) (Hondroyiannis, 2006):

PrS = (Y – T) – C;

Given the Ecoland figures according to which the total income before taxes (Y) equals 10,000, consumption amounts to 6,000, taxes reach the level of 1,500, and the expenditures (G) equal 1,700, the private saving will be as follows:

PrS = (10,000 – 1,500) – 6,000 = 2,500

Another important notion to define is the public saving (PbS), which is in the essence the difference between the taxes paid by the company and its expenditures (Mankiw, 2008). In Ecoland, public saving will be calculated according to the following formula:

PbS = T – G

Given the above figures according to which Ecoland’s expenditures amount to 1,700 and taxes reach the level of 1,500, the public saving will be:

PbS = 1,500 – 1,700 = – 200

The deficient public saving illustrates the problem in the finance of Ecoland, which needs to pay more attention to its financial policies and especially to expenditures (Mankiw, 2008). However, the national saving (NS) of Ecoland balances the relation between the private and public savings being the sum of the latter (Mankiw, 2008):

NS = PrS + PbS

Having calculated the PrS and PbS, we can now state that the national saving of Ecoland amounts to 2,300 according to the formula:

NS = 2,500 + (-200) = 2,300

Further on, the equilibrium interest rate should be calculated using the formula according to which first the investment rate of Ecoland should be defined (Ferguson, 2004). As far as Y (total income before taxes) equals 10,000 being the sum of expenditures (G), consumption (C), and investment (I), we can present it in the following equation:

Y = C + G + I, where C = 6,000 and G = 1,700

Accordingly, to calculate I we need to extract the sum of consumption and expenditures from the Y total. Thus,

I = Y – (C + G)

I = 10,000 – (6,000 + 1,700) = 10,000 – 7,700 = 2,300

Thus, given the Ecoland investment amount at the level of 2,300, it is now possible to reverse the governmentally used equation for the investment function to calculate the interest rates used at Ecoland. In the equation I = 3,300 – 100r, r is used to reflect the very interest rate we are interested in. So, to calculate this interest rate, i. e. the equilibrium real interest rate we need to extract the sum of the investment from the total assumed to the average income level of Ecoland (Ferguson, 2004). Accordingly, the equation to calculate the equilibrium real interest rate will look as follows:

If I = 3,300 – 100r, then

100r = 3,300 – I

Having considered the Ecoland investment and calculated it at the level of 2,300, w can clarify the equation for it to look as follows:

2,300 = 3,300 – 100r

100r = 3,300 – 2,300

100r = 1000

r = 1000/100 = 10

Thus, equilibrium real interest rate of Ecoland is 10% as can be seen from the equations used by the government to calculate the company’s investment and from the calculations of private, public, and national savings.

References

1. Ferguson, W. R. (2004). Equilibrium Real Interest Rate: Theory and Application. Retrieved August 20, 2009, from The Federal Reserve Board.
2. Hondroyiannis, G. (2006). Private saving determinants in European countries: A panel cointegration approach. The Social Science Journal, 43(4), 553 – 569.
3. Mankiw, G. (2008). Principles of Economics. South-Western College Pub; 5 edition.