In a closed economy, what is the relationship between savings and investment?

In a closed economy, the fundamental relationship between savings and investment is captured in the identity that total savings must equal total investment. This is because, in a closed economy, there are no external flows of capital or trade with other countries, leading to the balance where what households and businesses save must exactly match what is being invested in new capital.

When individuals save money, these savings are typically channeled into investments through financial institutions or directly into businesses and projects that need funding. Thus, every dollar saved provides the potential for a dollar of investment. This equality is crucial for maintaining equilibrium in the economy—if savings were to exceed investment, it would imply that excess savings are not being utilized for productive purposes, potentially leading to economic stagnation. Conversely, if investment were to exceed savings, it would necessitate borrowing or a depletion of current savings, which is not sustainable in the long run in a closed economy.

This direct connection between savings and investment ensures resource allocation is efficient and reflects the broader dynamics of demand and supply within the economy. Hence, the option asserting that investment must equal savings effectively encapsulates this essential macroeconomic principle.