Lecture on Savings and International Trade

Jul 13, 2024

Lecture on Savings and International Trade

Savings

Importance of Savings

  • Critical for economic growth.
  • Increased savings → increased capital supply → lower interest rates → higher Net Present Value (NPV) of investment → increased investment.
  • Low savings rate in the US (~3-5%) compared to Europe and Japan (~15+%).

Public Policy and Savings

  • Major tool: Tax subsidies for retirement savings.

Tax Subsidies for Retirement Accounts

  • Logic: Interest on savings typically taxed, reducing net earnings.
  • Retirement accounts (e.g., 401(k), IRAs) allow tax-deferred growth.

Benefits of Tax-Deferred Accounts

  • Example: Tax-deferred account provides higher returns due to delayed taxation.
  • Compounding of interest and delayed tax payments enhance returns.
  • Encouraging use of retirement accounts increases national savings.

Investment Strategy for Retirement Savings

Investment Options in a 401(k) Plan

  1. Money Market Funds:
    • Invest in government bonds; low risk, low return (1-3% interest).
  2. Bond Funds:
    • Invest in corporate bonds; moderate risk, moderate return (4-5% interest).
  3. Stock Funds:
    • Invest in corporate equity; high risk, high return (≈7% annual return).

Risk-Return Trade-Off

  • Safer investments typically offer lower returns.
  • Riskier investments offer higher potential returns but higher variability.
  • Diversification is key: Spread investments to balance risk and return.
  • Avoid investing heavily in employer’s stock due to risk of tying investment to job security (e.g., Enron example).

International Trade

Introduction to International Trade

  • Current debate: Trade deficits and their importance.
  • Example: Trade of roses from Colombia versus domestic production.

Key Concepts

  1. Exports: Goods sold to other countries.
  2. Imports: Goods bought from other countries.
  • US: Exports $1.6T, imports $2.4T, resulting in $800B trade deficit.
  • Trade deficit ≠ inherently bad; it is about achieving a balance where both parties benefit through trade.

Understanding Trade Deficits through Example

  • Trade example using Pikachu and Jigglypuff illustrates trade deficits and surpluses.

Benefits of International Trade

  • Allows specialization based on comparative advantage.

Production Possibility Frontier (PPF)

  • Shows maximum output combinations with given inputs.
  • Economies of scope: Doing some of both activities can be more efficient than specializing in just one.

Comparative Advantage

  • Core concept in trade economics.
  • Based on opportunity cost: Countries should specialize in what they are relatively better at producing.
  • Example: US (computers) vs. Colombia (roses) demonstrates comparative advantage.
  • Specialization and trade lead to more efficient production and higher overall output.
  • Example: US produces computers, Colombia produces roses, resulting in higher total output when they trade.

Conclusion

  • Savings play a crucial role in economic growth, incentivized by tax-deferred retirement accounts.
  • Diversified investment strategies balance risk and return.
  • International trade, driven by comparative advantage, enhances global efficiency and output by allowing countries to specialize based on their strengths.

Upcoming Topics

  • Detailed welfare analysis of international trade.
  • Further discussion on risk preferences and their impact on investment and trade decisions.