Describe the relationship between consumption saving and investment

describe the relationship between consumption saving and investment

Chapter 5 1 Explain the relationship between consumption and saving The from In order to encourage savings, I would give incentives for those investing in. Consumption function Determinants of Consumption Engel's law Savings Induced consumption CI describes consumption expenditure by households the relationship between the level of consumption expenditure and the level of income. Induced consumption CI describes consumption expenditure by households on goods The consumption function shows the relationship between the level of.

In every year stock of capital expands through net investment.

describe the relationship between consumption saving and investment

On the other hand, by saving we mean the part of the income which has not been spent on consumer goods and services. In other words, saving is the difference between income and consumption expenditure. It is worth noting that in consumption expenditure all types of expenditure are not included.

If an individual spends a part of his income on providing irrigation facilities, on buying tools and machinery, then that expenditure is not the consumption expenditure, it is in fact an investment expenditure. In order to obtain the saving, we have only to deduct the consumption expenditure from income and not the investment expenditure. When an individual makes investment expenditure he is deemed to spend his saved income on investment.

describe the relationship between consumption saving and investment

The expenditure of Rs. If Y represents the national income of a country and C the total consumption, then the saving of the country will be equal to Y — C.

Pre-Keynesian economists were of the view that savings and investment are generally not equal. This is firstly because saving and investment are made by two different classes of people.

While investment is undertaken by entrepreneurial class of the society, saving is done by the general public. Secondly, saving and investment depend upon different factors and are made for different purposes and motives. Therefore, it is not inevitable that savings and investment of a society must always be equal.

It was thus pointed out that more amount of investment than savings is possible because excess of investment over savings is financed by new bank credit. But Keynes expressed a totally opposite view that saving and investment are always equal.

describe the relationship between consumption saving and investment

The sense in which savings and investment are always equal refers to the actual savings and actual investment made in the economy during a year. They are also called ex-post saving and ex-post investment. If we have to calculate that during the yearhow much actual savings and investment have been made in India, we will have to deduct the total consumption expenditure made by the citizens of India during that year from the national income.

Likewise, the real investment during the year of the Indian economy will be obtained by summing up the investments actually made by the Indian people during that year.

Relationship between Saving and Investment | Economics

In fact, national income estimates of savings and investment are made in this actual or ex-post sense. The second sense in which saving and investment words are used is that in a certain year how much saving or how much investment people of the country desire or intend to do. They are also called ex-ante saving and ex-ante investment.

Thus, he used the word saving and investment in the ex-post or actual sense and proved the equality between saving and investment in the following way: Income of a country is earned in two ways: That is, national income of a country is composed of the value of consumer goods and services and the value of capital goods.

describe the relationship between consumption saving and investment

This can be expressed in the form of the following equation: The above equation represents the production or earning side of the national income. The second aspect of national income is the expenditure side. The total national income can be fully consumed but generally it does not happen so.

The Relationship between Saving and Investment (Explained With Diagram)

In actual practice, a part of the total income is spent on consumption and the remaining part is saved. From this we get the following equation: In the above two equations i and ii it is clear that national income is equal to the sum of consumption and investment and also equal to the sum of consumption and saving. From this it follows that: In equation i investment is that part of national income which is obtained from the production of goods other than those consumed and equation ii saving is that part of national income which is not spent on consumption.

Hence the actual or ex-post sense, saving and investment by definition are equal. It is worth mentioning that in macroeconomics, saving and investment do not refer to the saving and investment by an individual; they refer to the saving and investment of the whole community or economy.

Saving and investment by an individual can differ but in the ex-post sense, the saving of the whole country must always be equal to the investment.

describe the relationship between consumption saving and investment

Now the question arises, why ex-post saving and ex-post investment are always equal. For instance, when more investment is undertaken by the entrepreneurs how actual saving becomes equal to this larger investment and if the saving falls how investment will become equal to smaller savings. In this connection it is worth mentioning that modern economists, as did Keynes, include the addition to the inventories of consumer goods in investment.

Now, when saving increases, it implies that consumption will be less. In fact, investment is the demand for capital goods. Since firms will reduce output, in equilibrium the amount companies invest in the amount they wish to invest including inventoriesgiven current market conditions.

The Keynesian short-run consumption function tells us how much people will wish to consume at each level of income. But since saving is a residue i.

Saving is just income minus consumption: National income equilibrium occurs at point E where the desired saving function intersects the desired investment function. But planned or desired ex-ante saving is equal to planned or desired ex-ante investment only when national income is in equilibrium.

When we talk of saving and investment being equal, we are referring to the observed behaviour of an economy; a study of what has actually happened or what has been realised. But the Keynesian analysis of income determination revolves around the intended nature of such variables as saving and investment.

These plans to save and invest lead to changes in the income flow, with different equilibrium levels being reached. Decisions to save and invest are constantly being made by different groups of people at different times and for different reasons.

So there is very little chance of these plans being equal to each other within the same time period. When any discrepancy between the plans to save and invest occurs a change in the level of income brings about a state of disequilibrium, and as income continues to change so do these plans get readjusted until a level of income is reached where planned saving and investment are once more equal to each other.

It is only then that equilibrium has been attained where there is no tendency for the level of income and employment to alter. This process is facilitated by a multiplied change in income which operates both in an upward and in a downward direction. A simple numerical example may clarify the above: The table gives a consumption function, from which saving plans can be obtained.

  • Relationship between Saving and Investment | Economics

When income is the consumption schedule indicates that will be consumed, leaving the remainder to be saved. With planned saving and investment being equal, the economy is in a state of equilibrium — there are no forces at work changing the level of output or income. However, at the higher level of income planned saving exceeds planned investment resulting in planned expenditure failing below planned income. As the rate of production exceeds the rate of sales by 20 the level of stock will rise thereby resulting in a rise in unplanned investment.

Any stock changes are regarded as changes in investment. At this stage, realised investment, made up of planned and unplanned investment, will still be equal to realised saving, but the discrepancy between the intentions of savers and investors will result in the level of income falling back until it reaches the equilibrium level of An exactly opposite process will work itself out if actual income falls below its equilibrium value.