A primer on how the economic engine works through coordination between savers, investors, consumers, producers, governments, and banks. How hoarding and unfair competition can lead to economic distortions.
Topics covered include:
- How spending and saving are connected including the paradox of thrift
- How borrowing money can lead to higher income and savings and potentially to bubbles
- How hoarding differs from investing and why too much hoarding can deprive businesses of capital
- How lightbulbs, grocery stores, and kitchen appliances could be examples of unfair competition and planned obsolescence.
- What role do we play as participants in this coordinated economic dance?
Show Notes
Wait, Is Saving Good or Bad? The Paradox of Thrift—The Federal Reserve Bank of St. Louis
Rents: How Marketing Causes Inequality by Gerrit De Geest—Beccaria Books
FTC Challenges Kroger’s Acquisition of Albertsons—Federal Trade Commission
The Lifespan of Large Appliances Is Shrinking by Rachel Wolfe—The Wall Street Journal
Episode Sponsors
Betterment – the automated investing and savings app
LinkedIn Jobs – Use this link to post your job for free on LinkedIn Jobs
Become a Better Investor With Our Investing Checklist
Become a Better Investor With Our Investing Checklist
Master successful investing with our Checklist and get expert weekly insights to help you build your wealth with confidence.
Related Episodes
288: Will Early Retirements Crash the Economy?
222: Why We Overpay and How It Contributes To Income Inequality
Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 470. It’s titled “How the Economy Really Works: Savings, Investing, Consuming, and Market Distortions.”
In today’s episode, I want to go back to the basics—how everything is connected. The important linkages between spending, income, production, investing, and what about hoarding, and other market distortions. There are some identities, some relationships that are so key to the economy that we really need to understand them, and frankly, be fascinated by them, how this economic dance works. We can understand the linkages, but we’re never sure how businesses will react, how households will react, what the government will do. So let’s take this review, look at how everything is connected together.
Spending Equals Income
The first identity is that spending in the economy equals income. Every dollar spent in the economy is someone else’s income. Our salary, our income that we get from our employer is an expense of our employer. When our employer buys desks for its employees, that boosts the income of the manufacturer of the desk. That’s the first identity—spending equals income.
Savings Equals Income Less Spending
The second identity is that savings equals income, less spending. If we’re trying to save personally, we have to spend less than we receive in income. If we’re trying to save 10% of our income, then we spend 10% less than what we took in. In the US, the personal savings rate last month was 3.8%. That’s the amount that households saved as a percent of their disposable income. Disposable income is income after paying taxes. Now, that’s personal savings, household savings.
Businesses also save. When a business spends less than it receives in revenue, in its sales, that savings is called profits. Corporate profits are business savings. The more our employer spends on salaries, the lower its profit or business savings. Now, that brings up sort of a conflict. Spending equals income. But in order to save, we have to spend less than our income. And that means when we save, we’re depriving someone else of their income.
The Paradox of Thrift
What happens then if everyone tries to increase their savings at the same time? This is known as the paradox of thrift. It’s associated with the economist John Maynard Keynes. When a large portion of the population increases their savings, then spending decreases, because in order to save, we have to spend less. Businesses then, because they see less demand, produce less.
And if businesses are trying to save more, boost their profits, then they’ll buy less from other businesses; they may have fewer workers. And so across the economy, overall income falls as households and businesses try to save more because they’re spending less. And because every dollar spent is someone else’s income, if everyone is trying to save more by spending less, then overall income can fall.
Katarina Vermann wrote about this for the St. Louis Fed. She wrote “Let’s assume I want a new computer, so I start saving an extra $100 each month that I would otherwise spend going out to eat. By choosing not to spend that $100, I deny the waitstaff at my favorite restaurant some work hours and tips. I eat some portion of their income.
As a Money For the Rest of Us Plus member, you are able to listen to the podcast in an ad-free format and have access to the written transcript for each week’s episode. For listeners with hearing or other impairments that would like access to transcripts please send an email to team@moneyfortherestofus.com Learn More About Plus Membership »
