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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Introducing Economic Concepts

Introducing Concepts - Savings and Investment


Savings and Investment

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So let's introduce two more important concepts here. The idea of savings and investment. So when we say savings in this case, we're thinking about measuring the amount of output being consumed right now, compared to what is actually being produced. So current consumption consumption being uh, the output consumed would be the output. That's like used up right now, right, that we're actually consuming it right? When we produce things in our in our um in our economy, things that are being purchased by the final user, things that are being used up by the final user, right? When, when we have current consumption and current output, well, that's what's being produced in the same time period. Right? So when we think about savings, that means that consumption is less, the current consumption is less than the current output. Right? We're producing so much in our society, but we're saving some, we're not gonna consume it. All right now, we're gonna save some of it for future consumption. Okay, so savings is this idea of consuming less than what's produced, compare that to investment. So investment is where we're taking the current resources, things that we have now, but instead of um using them for current consumption, what we're gonna do is we're going to devote them to increase our future output so that in future years we can output even more to have more room for safe and more room for consumption in future years. Okay, so, savings is the idea of we're consuming less than the output, where investment is where we're investing into the future. So we're increasing future output by taking current resources and devoting them to the future output. Okay, now, when we say investment, when in your head you might think of investment and you might think of, oh, I'm gonna buy an investment, I'm gonna buy stocks on the market. Well, when we're taking economics, we don't think of that as in the same way we talk about financial investments and economic investments. So when you when when you think about an investment, you generally think of something like stocks, bonds, right? Things like that are financial investments, maybe like a mutual fund, right? These these all represent financial investments that you can make. However, in this class, when we talk about investment, we're generally going to be talking about economic investment. So when you see the word investment, you need to think about economic investment, which is generally investments that firms make, like a business might make to increase their production in the future, Right? Just like in our definition. So this could be like building factories, right? Putting money into um machinery, right? Buying new machinery to increase production, putting money into research and development, R and D. Research and development to increase future production. Right? So we're taking current resources and building a factory. So even though that factory isn't gonna help us right now, future years, we're going to get more production out of it, or machinery or researching a new technology that's going to make production faster in future years. Right? So economic investments, That's the key difference here, Right? Where a financial investment is something you might have been used to economic investment, they're focused on increasing future output. Okay, So when, when a firm is deciding to invest, they have to make a logical decision about investment, right? They have to think, why should we invest in the future instead of producing what we can right now, why should we take our resources and invest them in the future? So, they're gonna make those decisions if they have, uh, strong expectations of the futures. Right? So, when they make investment decisions, when a firm makes an investment decision, they're gonna have to have some sort of expectation about the future. So, if they have a good expectation about the future, well then they're going to invest current resources into increasing future production so that they can make more money over time. Right? So that would be an idea of why they would invest in the future. However, if they're pessimistic the opposite. If they're pessimistic about the future, how is that going to affect our our future output? Well, it's gonna lead to less investment, right? Because if they're pessimistic about the future, they're not going to invest into factories and machinery into the future. And and since there's less investment, well, it's gonna have less future consumption, because we are not devoting those resources to future consumption. Okay, so these expectations play a large role in how our economy flows. If they have good expectations about the future. Well, they're going to invest in the future right now. What if those expectations turn out to be wrong? Right, A firm might make expectations of, oh, we expect the demand for our product to be like this, or we expect to be able to supply this much of this product. Right. Well, if those expectations end up being wrong, we have what's called shocks. So demand shock, Well, that's related to demand, right? We had an expectation about demand and then we had an unexpected change in what we, what the level of demand was, right? We expected, oh, we're gonna be able to sell 10,000 cars, but we weren't able to sell 10,000 cars. Were only able to sell 8000 or it can go the other way. We expected 10,000 and we were able to sell 12,000, we don't have enough cars. Now, how is that gonna affect the economy? It's gonna have severe effects on the price levels on shortages of inventory. Things like that. Same thing can happen with supply as well, right? Supply, There could be an expected level of supply, but maybe some sort of raw material isn't available and they're not able to create the supply they wanted, right? Some sort of expectation is not met. So that's when we have a demand shock or supply shock that is when we have, uh, an expectation that is not met. So let's talk about these in a little more detail in our example, let's pause here and we'll go through that example in the next video.

Flexible Prices and Sticky Prices

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Alright let's go through this example. A chocolate here is considering opening up a firm to sell chocolate. She makes predictions about the future, expecting to be able to sell 500 boxes of chocolate per week at a price of $20 per box. So she's made expectations about the future and she's decided that she wants to invest in this right? She calculates that each box would cost her $18 to produce. Thus she can make a profit. She builds her factory and staffs it with workers to produce her optimal quantity of 500 boxes per week. Right? So she's made expectations about demand and expectations about the supply she's gonna have. Right? So there's two things that can happen here. Um let's make an assumption here that demand could could move around right? Maybe demand will be for that Um at a certain level that she predicted. And she'll be able to sell them for $20 a box or demand might be lower or higher than she excuse me, than she originally expected. So what if let's go first through this idea of a flexible price? What if she could have a flexible price meaning she could change the price from $20 down or up based on the level of demand that she actually experiences. So let's go through this graph here. So what we have is our standard price quantity graph that we're used to right? We've got price on the Y axis quantity here on the X. Axis and we have a flexible price. That means we're able to produce, notice our supply curve here, our supply curve is this red curve here and then we've got three different levels of demand. It could have been low demand medium. So let's label them like that. We have our low demand D. L. R. Medium demand or demand is higher than expected here D. H. We'll label them like that. So if we have a flexible price that means we could have the 500 units the optimal production that we wanted to produce the 500 units And we'll definitely get rid of them no matter what the demand is. We just have to adjust our price based on the level of demand. Right? So right here the d. medium this might be the situation that we expected right here right if the supply touches the demand right there this could have been the $20 price that we expected and we would sell all of our boxes of chocolate at the $20 price. But what if demand ended up being lower than we expected? We have to sell it at a lower price let's say down here. So now we're at the low demand. Right? This was the actual demand was the low one. Well now it's touching the supply curve a little lower and we're gonna end up with this lower price here. Right we'll still be able to sell all the boxes of chocolate And keep the same level of production but at this lower price. Now if there's higher demand than we expected. Well, the opposite, right? We could sell them at this higher price up here, maybe $22 and sell them all at that price. Right? So the main thing with the flexible price is that as you see down here It allows the firm to continue producing at the optimum quantity. We built this factory, right? We built a factory that was optimized to build to to produce 500 boxes of chocolate per week. Well, we don't have to have a fluctuation in the output because we can make sure that we sell all of that product at whatever the market price is. Right? So there's no short short run fluctuations in output and unemployment levels would not change, right? Because we can keep producing the same level. We don't have to fire people because we need to lower production or hire more people to increase production. We can keep that same level of production. The 500 boxes. Cool. Let's go through this other example here. The sticky prices. So there's a lot of products that have sticky prices and that the the people would not accept a different price than what is available on the market. So let's say the price could not change from $20, right? If the price had to be $20, well then what would happen with these different level of demand? Let's go through these same examples. Let me get out of the way. So we can see the whole graph. So we have the same thing. We could have the medium demand right? Where we expected it, But demand could have been lower than we expected or higher than we expected. So what happens if we have that medium demand? Well, we would be able to sell all of our output the 500 boxes that we made, We would sell them at that price of $20. Right? But remember if we can't change that price, if we had to keep that sticky price of $20? Well, what would happen if demand was lower than $20? You would end up selling less boxes of chocolate, maybe 400 boxes of chocolate. Now, what if demand was higher? The same? The same thing, The opposite here. Right? We would have this higher demand and there would be demand for 600 boxes at this higher price. Right? So if we were only able to produce 500 they wanted 600 we would have a shortage there. Now, what if that demand was lower? And they only wanted 400? Well, we would have what's called inventory left over. Right? So this is what what happens with sticky prices? If we go down here at the bottom, sticky prices caused the firm to keep inventory right? And and they're gonna maintain if they want to maintain the same level of production, Well, they're gonna have to keep inventory of the unsold boxes, right? So if we were in this case here Where we're only selling 400 boxes, but we have 500, we're producing 500, but only sell 400. Well, we're gonna have to keep that extra inventory of 100 right Now. What ends up happening if we have continuous demand? So if the continuously low demand, well, we're gonna keep having inventory. So what if every week we're only able to sell 400 and um we're producing 500? Well, we're gonna have more and more inventory and eventually we're not gonna need to produce anymore, right after four weeks we'll have a whole week's worth of inventory and we don't need to produce any that week, it's gonna lead to reduce output and then we might even lay off some workers, right, we'll have increased unemployment because of that. So if we maintain the same level of production, we're gonna have to keep inventory. Cool, so um this leads to uh reduced output because we don't we no longer need to produce uh inventory, or excuse me, need to produce new new new production uh when we have inventory backed up like that. Cool, so this is the two separate situations of what can happen, we can have flexible prices or sticky prices, as we see in these two situations. Um And generally what we'll see is that there's some products that can have more flexible prices and some that will have sticky prices. Cool. Um, for now, that's about it. We don't need to go into too much detail other than understanding, you know, what a flexible price is that it can move up and down. It's flexible. What a sticky prices, something where the price has to stay relatively firm. Right? And the overall discussion here of saving and investment, we're going to go into all of these topics in more detail in future chapters in future videos. So let's go ahead and pause here and move on to the next video.