Here are 4 points from my class.

• Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption.

• Consequently, the accumulation of capital involves a tradeoff.

• When governments encourage saving and investment, they also encourage growth and in the long run this raises the standard of living.

• A well-functioning and carefully regulated financial market, one that quickly and efficiently brings savings and investment together with minimal risk and in a transparent way, is a critical ingredient in the recipe for economic growth.

I can conclude that saving and investment are good for growth, but I cannot tell exactly why. Can someone make it clearer, maybe with a concrete example?


2 Answers 2


The result you are asking about follows more formally from the Solow model. It's definitely worth looking into. I won't go into the model specifics, since I believe you are after a simple example.

First, note that what economists refer to as capital is not really what most people mean when talking about capital. For us, capital is typically a production factor that is not labor. A good example is a machine. For agriculture it could also be something like fertilizer. These are all things that help you produce more and that is how you get growth from capital.

Suppose you are a farmer who can produce 10 potatoes a year currently. You sell those potatoes and then can decide to spend that money consuming (e.g. buying steaks) or you can invest it in "capital". If you spend the money on a tractor and some fertilizer, you can produce 20 potatoes next year. That is how investment leads to growth. That is also why you need to give up some consumption today in order to grow your production and have more consumption tomorrow.


Well, define investment then... Investment in capital basically means that the capital will generate better returns in the future (that is at the end of the investment period)

The equilibrium is the time preferences of the suppliers, of any good, for an X return on capital now, or an *X * (1 + y%)* in the future. That is, that at certain level of y the supplier (of any product for that matter) will be indifferent

This supplier time preference is the ingredient of the demand function for capital

Assuming we have functioning capital market, with an equilibrium of expected future returns, time preferences can be traded

In such a manner, our supplier can borrow money, assuming that equilibrium prices (bond markwt yields, for example) are lower than his time preference represented by y are being done, or he can lend money should prices be higher


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.