What it means
Economists often divide the economy into groups of units: households, firms, governments and the rest of the world. In any period, each unit will either spend less than its income, spend exactly its income or spend more.
Those in the first group are the surplus spending units, and those in the third are deficit spending units. Households are the classic example.
Many earn more than they spend, so they put money in bank accounts, pension funds and investments. The money does not sit idle, because financial institutions lend it on to those who need it.
Companies and governments can be either. A profitable business with more cash than it needs may be a surplus unit for a year, while the same company may become a deficit unit when it borrows to build a factory.
A government that runs a budget surplus is a surplus unit in that period. The concept is useful because it shows what financial markets are for.
They channel savings from surplus units to deficit units, whether through bank loans, bonds or shares, and in return the savers receive interest, dividends or growth. When this process works well, the economy can invest more than any one saver could fund alone.
The nuance is that the status is temporary and depends on the period measured. A household can be a surplus unit in its working years and a deficit unit in retirement, and a start-up is almost always a deficit unit at first.
For the economy as a whole, total surpluses and deficits must balance, once the rest of the world is included.
In practice
Real-world examples.
Example
A dual-income couple with no children earns $150,000 after tax and spends $110,000. They save the difference in a retirement account, which indirectly funds loans to companies and home buyers. In that sense their surplus of $40,000 a year becomes someone else's mortgage or business loan.
Example
A technology company generates $30 million in cash from operations and spends $22 million on running costs and investment. It keeps the $8 million surplus in short-term deposits until it decides on an acquisition. While it waits, the surplus earns interest and is, in effect, lent to the bank's other customers.
Example
A government with a budget surplus collects more in taxes than it spends and uses the extra money to pay down debt. This reduces its borrowing needs and frees up savings for other borrowers. Lower government borrowing can also put downward pressure on interest rates for everyone else.
Formula
Calculation
Surplus = income - spending
Surplus rate = surplus / income
Suppose a household has an after-tax income of $90,000 for the year and spends $72,000 on living costs. The surplus is 90,000 - 72,000 = $18,000. The surplus rate is 18,000 / 90,000 = 0.20, or 20% of income. That $18,000 can be deposited, invested or lent, and becomes funds available to a deficit unit such as a business or home buyer.Case study
Seen in the real world.
Meadowbrook Credit Union is an illustrative, fictional lender serving a mid-sized town. Its finance director noticed that members aged 45 to 60 held large deposits while younger families were asking for mortgages and car loans.
She described the town in terms of surplus and deficit units. The older group, with an average annual surplus of $15,000 a household, were the surplus spending units, and the younger families who borrowed were the deficit units.
By pricing deposits and loans sensibly, the credit union matched the two groups. In this illustrative story, it lent out $24 million of members' savings at an average margin of 3%, which earned about $720,000 a year to cover costs and build its capital. The finance director now reports the balance between surplus and deficit members to the board every quarter.
Watch out
Common mistakes.
- Assuming that surplus units are always rich, when a modest household that spends slightly less than it earns is also a surplus unit.
- Treating the status as permanent, when most units move between surplus and deficit as circumstances change.
- Forgetting that a surplus is only useful to the economy if it is saved or invested, and not held as idle cash for long.
Questions
People also ask.
What is the opposite of a surplus spending unit?
A deficit spending unit, which spends more than its income and so has to borrow, sell assets or use past savings.
How do surplus units connect to deficit units?
Mostly through banks, bond markets and stock markets, where savers supply funds and borrowers use them.
Can a company be a surplus unit?
Yes, any company that earns more cash than it spends in a period is a surplus unit for that period, even if it borrows at another time.
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