National Income Concept of Consumption Saving and Investment

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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.

FAQ (Frequently Asked Questions)

1. What are consumption and investment?

Consumption is considered as the usage of goods and services that got purchased by a person to fulfil his/her needs. The amount of money he spent to purchase these goods and services are termed as consumption expenditure. Investment is considered as the expenditure that is spent on capital goods. This expenditure was made with the sole motive of income generation. In simple words, investment is the purchase of goods that is not used today but gets used in future for the generation of wealth. Investment also involves the production of fresh capital goods such as plants, equipment and many other goods.

2. What are the types of consumption?

Consumption gets classified into two types which are:-

Direct or final consumption: When the goods or services that are consumed by a person, satisfies his/her wants directly or immediately this type of consumption is known as direct or final consumption. For example, the takeaway of meals, using furniture, etc.

Indirect or productive consumption: When the goods that get purchased are not for final consumption but act as raw materials and get consumed to produce final products that satisfy the wants of the customers, this type of consumption is known as indirect or productive consumption. Without this type of consumption, direct consumption can't take place.