The Saving/Investment Approach to Equilibrium

Let’s begin with a closed economy with no government or foreign trade. In this two-sector model, macroeconomic equilibrium can be seen as a balanced seesaw, with savings on one side and investment on the other.

We begin with a basic identity in macroeconomics: total income, represented by Y, is the sum of consumption (C) and savings (S). This gives us:Y = C + S.

Simultaneously, equilibrium in the goods market is represented by Y = C + I, where I stands for planned investment.

Since both equations express total income, we can set them equal: C + S = C + I.

Subtracting consumption from both sides results in the condition S = I. This identity—savings equals investment—is the tipping point that determines whether the economic seesaw remains balanced.

Suppose Alex has a disposable income of five hundred dollars and spends four hundred seventy-five dollars. His savings would then be twenty-five dollars. If the level of planned investment in the economy is also twenty-five dollars, then savings equals investment.

Thus, the economy is in equilibrium, keeping the seesaw perfectly balanced.