Savings-Investment Relation

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    What is the proper explanation of the relation between savings and investment? The mainstream exposition, proposed here in my college macro textbook (Macro, 6th ed.) authored by Greg Mankiw (who else) is as follows:

    S=I for the economy as whole
    “this does not have to be true for every individual household or firm.”
    His definition of savings: “suppose L earns more than he spends and deposits his unspent income in a bank or (!) uses it to buy some stock or a bond from a corporation…..L might think of himself as “investing” but the macroeconomist would call L’s act saving rather than investment.”
    His definition of investment: “purchase of new capital, such as buildings or equipment.”
    Also of note, Mankiw stresses the idea that the purchase of a house is an investment (giving no consideration to the notion of housing as a consumer good)

    In Mankiw’s exposition it seems that savings and investment compete with each other yet equal each other. Isn’t the real competition between savings-investment and consumption? However aren’t Keynesians “agnostic on the factors determining investment” (Rothbard MES, p.860, 2nd ed.)?

    I find Mankiw’s macroeconomics to be utterly confusing, can someone help me out with this?


    Saving is postponing consumption. Investing is making capital goods. Obviously S=I in all cases.

    In self-sufficiency, Robinson Crusoe, to devote resources to making capital goods by which he makes consume goods more indirectly, he must divert them from making consumer goods more directly. He gives up picking coconuts to make a net and then use the net to catch fish. His saving is the reduction in his coconut consumption that is done to release his labor into making the net, which is his investment.

    In the division of labor, one person postpones his consumption by lending present money (called financial investing or making an investment expenditure) to an entrepreneur who uses the funds to bid for the production of capital goods, which is making an investment. (If one person saves and makes a financial investment to someone else who uses the funds to bid for the production of a consumer good, then no social saving-investing has taken place.)

    Saving and investing are two steps to a single process called capital formation. You are correct, consumption competes with S-I. A person’s time preference determines the split between S-I and consumption.

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