What is the relationship between saving and investment in a closed economy?

In the context of a closed economy, the relationship between saving and investment is defined by the fundamental identity that total savings in an economy must equal total investment. This relationship holds because, in a closed economy—one that does not engage in international trade—everything that is saved is used for investment.

When households save money, it is usually deposited into banks where it gets pooled and lent out for various investment opportunities, such as buying machinery, constructing buildings, or starting new businesses. Thus, all the money saved ultimately contributes to investment in the economy. This means that the funds that are not consumed are available for investment purposes, making it necessary for total savings to equal total investment.

Additionally, the equality arises from the circular flow model of income and expenditure, where the income not consumed becomes savings and is channeled into investment, thereby bolstering the economy's ability to enhance productive capacity. Hence, in a closed economy, savings and investment must always be equal to ensure a balanced flow of resources and economic stability.