Concept of Savings, Consumption, and Investment
When there is economic development in a country it means that there is growth or improvement in the standard of living of people living in that particular economy. Along with this, a sustained growth rate also gets witnessed. In order to gain more knowledge on this factor let's discuss the concept of savings, consumption, and investment. We will discuss each of these three variables and how they are related to each other. These three variables have a relationship that is based upon the classical system.
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Consumption
The main hypothesis that was given by Keynes suggests that the disposable income of a person which gets calculated by deducting the tax liabilities from the gross income of the person affects and influences the person's consumption level. To explain this theory in a detailed way, there is some further information on this topic:
C = f(Y), in this equation C, represents the consumption of a person whereas Y represents the disposable income of the person.
Keynes also expressed his views on people's consumption patterns. Keynes believed that with the increase in disposable income, people tend to increase their level of consumption. However, the increased rate of disposable income seems to be greater than the increased rate of consumption. Disposable income is always greater than the rate of consumption. This hypothesis of Keynes is considered as a person's marginal propensity to consume and indicates the positive correlation that exists between these two variables.
Thus to understand this concept more clearly here's an example if a person's income rate increases by one unit then his/her marginal propensity to consume sees a rise of approximately 0.8 units. The rest of the 0.2 units that were left untouched gets used for savings. Here's an equation representing this concept:-
Y = C + S
Here,
Y stands for disposable income
C stands for consumption
S stands for savings
The propensity to consume and the desire to consume are both different things and are distinct in nature. The former way of consumption is more effective than the latter.
The consumption rate of an individual gets affected by some objective and subjective factors. Objective factors that affect consumption are tax policy, interest rate, windfall profit or loss, and assets holding. Whereas some of the subjective factors are motivation to foresight, precaution, and improvement among individuals.
Savings in Economics
Before digging into the more advanced features of savings let us first understand what is savings in economics? Savings is considered as the excess of disposable income over the consumption or expenditure of a particular person. This is what is taught as savings definition economics.
From the national level point of view, the answer to what is savings in economics? Is quite different. Here it means that savings are the unconsumed part of the whole country's income that got generated in a financial year.
Determinants of Savings
Income, the saving income ratio maintains a relationship with the rise in income. People usually try to save an excess or larger part of their income despite the entire bulk.
Savings gets largely affected by the inequality of income distribution. People, in order to showcase their superior standard of living, tend to purchase expensive goods that in turn decrease their level of savings. They buy these goods to compare their standard of living with their immediate neighbors.
Psychological or subjective factors affect the savings habit of people. People who are worried about the uncertainty of the future tend to save more. These psychological factors can boost up a person's saving habits.
Financial instruments with a good return on investment and increased savings account interest rate motivates people to save more money.
From the determinants of savings in economics, a person can get a clearer view on savings definition economics thus, strengthening the core knowledge on this particular field.
Investment
An investment is considered to be a process of acquiring an asset with the sole motive to generate some income from that particular asset. Increase in the value of these assets with time helps in generating income. When an individual invests his/her money on a good, its motive is not to consume it but to generate wealth from it in the coming future.
How are Savings and Investment Related?
There exists a saving and investment theory which is based upon the classical system. According to this theory, savings get equated with investment automatically which in turn affects or alters the interest rate. If the savings of a person exceeds his/her investments then this excess of funds reduces the rate of interest.
FAQs on Consumption, Saving, and Investment in National Income
1. What are consumption, saving, and investment in economics?
In economics, these terms have specific meanings related to national income:
- Consumption (C) is the total spending by households on goods and services to satisfy their immediate wants.
- Saving (S) is the part of income that is not spent on consumption. It represents income set aside for future use.
- Investment (I) refers to the expenditure on capital goods, such as machinery, equipment, and buildings, which are used to produce more goods in the future.
2. What is the difference between autonomous consumption and induced consumption?
The main difference lies in their relationship with income. Autonomous consumption is the minimum level of spending required for survival, which occurs even when income is zero (funded by savings or borrowing). In contrast, induced consumption is the portion of spending that changes directly with the level of disposable income; as income rises, so does this type of consumption.
3. How are consumption and saving related to each other?
Consumption and saving are the two components of disposable income. The fundamental relationship is expressed as Y = C + S (Income = Consumption + Saving). This means that for a given level of income, any amount not used for consumption is automatically saved. Therefore, a decision to consume more is simultaneously a decision to save less, and vice versa.
4. What determines the level of investment in an economy?
The decision to invest is primarily influenced by two factors:
- Marginal Efficiency of Capital (MEC): This is the expected rate of profit or return from an additional unit of investment.
- Rate of Interest (ROI): This is the cost of borrowing funds to make the investment.
A firm will typically invest only if the expected return (MEC) is higher than the cost of borrowing (ROI).
5. Why is saving often called a 'leakage' and investment an 'injection'?
This relates to the circular flow of income in an economy. Saving is a leakage because it is income that is withdrawn from the current spending stream and does not immediately return to it. On the other hand, investment is an injection because it represents spending (on capital goods) that adds money back into the circular flow, creating demand, production, and jobs.
6. How does 'investment' in economics differ from buying stocks or bonds?
This is a common point of confusion. In macroeconomics, investment refers to the creation of new physical capital (like a new factory or machine) that increases an economy's productive capacity. Buying stocks or bonds is considered a financial transaction that simply transfers ownership of an existing asset. It does not create new capital and is therefore not counted as investment in national income calculations.
7. What is the 'paradox of thrift' and why is it important?
The paradox of thrift is an economic theory that highlights a potential problem with saving. It states that if everyone in an economy tries to save more during a recession, aggregate demand will fall. This fall in demand leads to lower production, more job losses, and ultimately, lower total income for everyone. As a result, the total amount of saving in the economy might actually decrease, which is the opposite of what people intended.
