The world as a whole is a closed economy, of course. If Solovenia is an open economy, Juan has other options. He might decide that he can get a better return on his savings by investing in foreign assets (such as Italian real estate, shares of Australian firms, or Korean government bonds). Domestic investment would then be less than national savings. Juan is lending to the rest of the world. Alternatively, Juan might think that the benefits of investment in his home economy are sufficiently high that he borrows from the rest of the world to finance investment above and beyond the amount of his savings. Domestic investment is then greater than national savings. Of course, if Juan lends to the rest of the world, then he will have extra resources in the future when those loans are repaid. If he borrows from the rest of the world, he will need to pay off that loan at some point in the future. There may be very good opportunities in an economy that justify a lot of investment. In this case, it is worthwhile for an economy to borrow from other countries to supplement its own savings and build up the capital stock faster. Even though the economy will have to pay off those loans in the future, the benefits from the higher capital stock are worth it. The circular flow of income shows us how these flows show up in the national accounts. If we are borrowing on net from other countries, there is another source of funds in additional to national savings that can be used for domestic investment. If we are lending on net to other countries, domestic investment is reduced. Toolkit: Section 16.16 “The Circular Flow of Income” You can review the circular flow of income in the toolkit. investment = national savings + borrowing from other countries or investment = national savings − lending to other countries. Savings and investment in a country are linked, but they are not the same thing. The savings rate tells us how much an economy is setting aside for the future. But when studying the accumulation of capital in an economy, we look at the investment rate rather than the savings rate.
Don't use plagiarized sources. Get Your Custom Essay on
A Closed Economy
Just from $13/Page