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    Saving: Investment in a circular flow

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    Why does investment spending not equal saving in the circular flow?

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    Saving is equal to investment in a simplified circular flow economy without government and no international trade. In this simplified economy, all economic activities are the interactions between households and firms. In this ...

    Solution Summary

    In a closed economy with government, saving must equal investment. This is because outputs are either consumed by households (consumption) or by firms (investment). Unconsumed income must be equal to saving. It follows that saving is equal to investment. However, in an opened economy with government, the equality doesn't hold because saving and investment are also inclusive of from foreigners and some portion of income goes to taxes as well.