We all have an understanding of the concept of income on an individual level and what our own income is. But how should we measure the income of a whole economy? What is the relation between our income and the value of what we produce? To find the nation’s income do we just add up the incomes of the household, business, and government sectors? And how does the rest-of-the-world enter the picture? What does the nation spend its income on, and what does it save? How does savings relate to investment?
We have already mentioned bonds, and that they are marketable securities that are purchased by financial intermediaries like mutual funds and pension funds as well as by individuals. We are all aware of U.S. Government bonds, but we also know that you cannot buy stock in Uncle Sam! Clearly, bonds must be different from stocks, though both are investments. Now let’s be specific about what a bond is and how the bond market works.
When you mention the word "investment" most people think of Wall Street and the stock market, not capital investment in new plant and equipment by firms. These are two distinct uses of the same word. When someone buys 100 shares of Nike Corporation they are making a financial investment. When Nike Corp. builds a new factory or warehouse, it is making a capital investment. We need to be careful not to confuse financial investment by savers with capital investment by firms, although the two kinds of investment are closely related. Both of these “investments” are part of the process of turning household savings into the production and purchase of new capital goods. Both involve taking a risk now in the hopes of earning a larger return later. To develop the concepts of financial investment, let's continue our example of Blue Skies' purchase of a new Boeing 777.
Imagine that you are the president of Blue Skies Airlines, Inc. and you have decided that Blue Skies should buy a new Boeing 777. The plane will cost $125 million and change. There is one small problem though. Blue Skies only has a few million dollars in its bank account, and those funds are needed to pay fuel bills and the salaries of its employees. How can Blue Skies get enough money to buy this new airplane? It can by tapping into the savings flows of the economy, and this chapter explains how that actually happens.
Macroeconomics focuses on trying to understand events that affect the whole economy. In the fall of 2000 and continuing through the fall of 2001 there was the U.S. experienced a decline in sales, production, and employment that affected most firms and industries. A few industries, notably housing construction, continued to do well. This kind of widespread decline in economic activity, when it lasts for more than six months, is called a recession.