consumption and investment in micro/macro (chatgpt)

October 12, 2023

You:

Y = C + I + G

GDP = Consumption + Investement + Goverment purchase for closed enconomy

We can manipulate the equation to get Y - C - G = I

left side shows, Total output - total consumption And we call it national saving or saving, in short

if we denote the value by S It becomes S = I

i’m paraphrasing a economy text

ChatGPT:

You’re summarizing the basic equation for Gross Domestic Product (GDP) in a closed economy without international trade. Here’s a breakdown of your summary:

For a closed economy (an economy without exports or imports), the GDP can be represented by:

$Y = C + I + G$Y=C+I+G

Where:

• Y Y Y is the Gross Domestic Product (total output of an economy).
• C C C represents consumption, or the total value of all goods and services consumed by households.
• I I I represents investment, or the total spending on capital that will be used for future production. This includes business capital, residential capital, and inventories.
• G G G is government purchases, or the total government spending on goods and services. It excludes transfer payments like pensions and unemployment benefits since those are not payments for goods or services.

From the equation, if you rearrange terms to group the non-investment elements on one side, you get:

$Y - C - G = I$Y−C−G=I

The left side, $Y - C - G$Y−C−G, represents total income (or output) of the economy minus what is consumed by households and what is purchased by the government. This difference is effectively the amount of output that is not consumed—i.e., saved. Thus, it is called national savings, often denoted by $S$S.

Therefore, the equation becomes:

$S = I$S=I

In this simplified model, national savings is equal to the level of investment in the economy. This relationship underscores a fundamental economic identity: in a closed economy, one person’s savings can be used for another’s investment.

You:

great, here’s the question I wanted to ask, I sense here, the word saving or investement is overloaded to meam somthing different from what we used the word for the I and C when we defined the original equation.

When we introduced the I and C, it distinguishes the type of spending by (either type of purpose or type of result) whether it has benefited the increasement of Y (output or production)

It ’s clear that overloading is taking place because if we stick to what we meant when we defined I or C, the total of I would not be queal to the total of C.

So I conclude that we are overloading the term , as we do in many other places, for instance in accounting credit can mean slightly different things.

What do you think about my interpretation?

ChatGPT:

You’re touching upon an important subtlety in economic terminology and its conceptual implications. Let’s unpack this:

• Consumption (C) and Investment (I) Distinction:
  • Consumption (C): This refers to spending by households on goods and services. It doesn’t generate future income by itself. For example, when you buy food or a new pair of shoes, that’s consumption.
  • Investment (I): This refers to spending that will generate future income or output. Examples include businesses buying machinery, households buying homes, or inventory accumulation by businesses.
• National Saving (S) vs. Investment (I):
  • National Saving (S): As you noted, this is total income not consumed by households or the government. It’s the portion of the GDP that isn’t used for consumption or government purchases.
  • Investment (I): While the earlier definition holds true, in the context of the equation S = I S = I S = I, the term is also an indication of where the savings are going. Essentially, what’s saved in an economy (in a closed system) is exactly equal to what’s invested.
• Is There Overloading?:
  • In a way, yes, but it’s more about context than true overloading. The term “investment” maintains its core meaning in both contexts: expenditure that results in future production capability. But in the S = I S = I S = I context, it’s also implying that savings are channeled into these investments.
  • Consumption, on the other hand, isn’t being overloaded in the context you presented. It retains its meaning of current spending by households on goods and services.
• Why Doesn’t I I I Equal C C C?:
  • They measure different economic phenomena. Consumption is about current spending on goods and services for immediate use. Investment is about expenditure on goods for future use. The equation S = I S = I S = I doesn’t imply I I I equals C C C. Rather, it indicates that whatever isn’t consumed (or spent by the government) becomes the savings of the economy, and these savings are equal to what the economy invests.
• Analogy with Accounting:
  • Just as in economics, accounting terms may seem overloaded or context-sensitive. For instance, “credit” can mean an increase in liabilities or equity, or it could refer to the right side of the T-account, depending on context.

Your interpretation underscores a critical trait of economic (and many other disciplines’) models: they simplify complex realities. It’s essential to understand the context in which terms are used to grasp their nuanced meanings fully.

You:

oh i didnt mean C= I, as you seem to correctly infered yes S = I and saving were not equal to investment in micro sense, and we are saying in macro scope we treat them as equal.

Hence I used the term overloading. and yes, context wise, it is not as severe overloading as “credit” , since the “investment” retains the original intent we had (wheereas credit in accounting totally differnt)

but yes S is overloaded slightly. and I can see yes, we are expressing that total money saved could be used as investmment, and That is assumption we are making and that is overloading i’m refering to.

in micro scope, we didn’t allow that saving to be investment.

so the question has two parts actually

1. it looks like overloading , or if it’s not that severe, at least we are defining “S” by something other than original meaning to express the assumption that all resources (savings) are channeled into the investment
2. is the assumption valid? can we say that there’s no un-working savings

ChatGPT:

You’ve made some keen observations, and I can see where your perspective is coming from. Let’s address both parts of your question:

• Terminological Overloading or Recontextualization:
  • Investment (I): At the micro-level, when we think of individual actions, “investment” usually means deliberately allocating resources (often money) with the expectation of generating an eventual return. At the macro-level, “investment” captures all expenditures that contribute to future production capability. This might include things that individuals or businesses wouldn’t necessarily label as “investments” in everyday language, such as unsold inventory.
  • Saving (S): At the micro-level, an individual might consider their savings as money they’ve stashed away in a bank account or under a mattress. At the macro-level, however, “savings” represents all income not consumed—essentially, it captures the resources available for investment. You’re correct that there’s a shift in nuance here, which might be seen as a form of overloading or recontextualization. This shift in definition allows economists to equate macro savings with macro investment.
• Is the Assumption Valid?:
  • In a closed economy model (without international trade), the basic idea is that every bit of income that isn’t used for consumption (or government spending) is used for investment. This means that there’s no “leakage” of savings; everything is either consumed or invested.
  • In reality, there might be idle savings or underutilized resources, especially in the short run or during times of economic uncertainty. But over the longer term, in a closed economy, money that’s saved and not just hoarded does typically find its way back into the economy, often as investment.
  • It’s also worth noting that this strict equivalence of S = I S = I S = I becomes more complex in open economies with international trade. In such economies, the difference between national savings and domestic investment can equal the trade surplus or deficit.

In essence, economic models like this are simplifications of reality. They help us understand the fundamental dynamics of an economy, but they might not capture every nuance or exception. The assumptions made, like $S = I$S=I in a closed economy, are based on long-term observations and theoretical considerations, but they’re still idealizations.

You:

so i can sum up like this, so the slight nuance change is due to the fact that we are using the savings / investment in different time horizon.

where in microscope, we decide what is savings/insvestment right away. but in macroscope, we are assuming they converge.

So in a sense, we are not overloading , we are retaining the core meaning of savings/ investments, but we are extending or changing the properties of the words slightly to encompass the original meaning in the wider time range.

But the question remains, if the assumption is valid or not,. i think it’s rather big simplication to model the world with our words.

ChatGPT:

You’ve summarized the essence of the matter quite eloquently. The nuances you’ve identified arise from the difference in scope (micro vs. macro) and the time horizons you mentioned.

To recap:

• In the micro perspective, decisions regarding savings and investment are immediate and individual-centric. The distinction is clear: an individual either saves by storing money or invests by putting it into ventures expecting future returns.
• In the macro perspective, the distinctions become blurred due to the aggregate nature of the economy. We operate on the premise that in the long run, savings find their way into investments. This is less about changing the core meaning of the terms and more about considering their broader implications over extended periods.

Regarding the validity of the assumption:

• As with many models in economics, the S = I S = I S = I assumption in a closed economy is a simplification. In the real world, factors like liquidity traps, economic downturns, and shifts in consumer and business sentiments can lead to idle savings or underinvestment.
• Yet, the model’s strength is in its ability to depict a fundamental economic relationship and to provide a foundation upon which more complexities can be layered. For instance, introducing an open economy with international trade complicates the equation, and nuances like capital inflows and outflows have to be considered.

In essence, models are always simplifications of the real world. They are tools to help us understand complex systems, and while they may not capture every intricacy, they provide frameworks to understand the broader dynamics. It’s essential to recognize both their strengths and their limitations.

You:

you are pointing out another important distinction, where microscope deals with transactions in isolation and, on the other hand in macro, we are talking about the whole.

ChatGPT:

Absolutely. The difference in perspectives between microeconomics and macroeconomics is fundamental to how economics as a discipline approaches various questions and problems.

• Microeconomics:
  • Focuses on individual agents, such as households and firms, and their interactions.
  • Deals with specific markets and how prices are determined based on supply and demand.
  • Considers the decision-making processes of individuals and firms, factors affecting those decisions, and the implications of those decisions.
  • Topics might include the pricing of a specific product, wage negotiations for a particular job sector, or the decision-making process of a single business.
• Macroeconomics:
  • Focuses on the economy as a whole or its large sectors.
  • Deals with aggregate measures such as GDP, unemployment rates, and inflation.
  • Considers national policies related to monetary and fiscal policy.
  • Topics might include the reasons for economic downturns, the impact of tax cuts on the overall economy, or the effects of central bank decisions on inflation.

The distinction you’re making is insightful: in microeconomics, the approach is often transactional and based on isolated decisions, while macroeconomics deals with aggregate outcomes resulting from many individual actions.

Both perspectives are essential, and they often interrelate. For example, macroeconomic policies might shape the environment in which individual firms operate, while aggregate patterns in individual consumer and business decisions can lead to broader macroeconomic trends. The dance between the “individual” and the “aggregate” is a core aspect of the study of economics.