Consumption, Saving, and Investment

• This unit covers consumption, saving, and investment and their interrelationships.

Consumption

• Defined as household expenditure on final goods and services.
• Main components: food, housing, clothing, transportation, medical care.
• Consumption is directly linked to and dependent on income.
• Autonomous consumption: Minimum level of consumption required for survival when income is zero and is independent of income level.
• Induced consumption: The part of consumption that increases with income, but usually less than the income increase.

Determinants of Consumption Expenditure

• Money Income: Consumption expenditure has a positive and direct relationship with money income.
• Distribution of Income: Consumption expenditure per unit of income is higher for poor people than for rich people and an unequal distribution of a nation's income reduces consumption expenditure.
• Level of Direct Taxes: Higher direct taxes decrease personal disposable income and consumption expenditure, acting inversely.
• Expectation of the Future: Expectation of rising prices increases present consumption, acting inversely.
• Rate of Interest: Higher interest rates reduce consumption expenditure and increase savings, also acting inversely.
• Level of Wealth: Higher wealth leads to more consumption expenditure, acting inversely.

Consumption Function

• It is a key tool in macroeconomics showing the relationship between consumption and income levels.
• It is also known as propensity to consume.
• It indicates how consumption responds to different income levels.
• C = a + bYd, where 'a' is autonomous consumption, 'b' is the percentage of income for consumption, and 'bYd' is induced consumption.
• Consumption refers to the amount of income spent on goods and services at a given level of income.
• Consumption function refers to the schedule showing consumption expenditure at various income levels.

Average Propensity to Consume (APC)

• APC is the ratio of total consumption expenditure (C) to total income (Yd), symbolically APC = C/Yd.

Marginal Propensity to Consume (MPC)

• MPC is the ratio of change in consumption (ΔC) to change in income (ΔYd), indicating the desire or urge to consume, and is symbolically expressed as MPC = ΔC/ΔYd.

Properties of MPC

• MPC is greater than zero but less than one, since part of the income increase is saved.
• MPC decreases as income increases and a community becomes richer.
• MPC is higher for the poor class than for other classes due to unfulfilled basic needs.
• MPC is stable in the short run because it depends on psychological factors.

Saving

• Savings refers to the part of income not spent on consumption.
• Savings depend directly upon income.
• As income increases, savings also increase, and at a higher rate than income increase.
• Savings are negative at low income levels.

Determinants of Saving

• Level of Income: Savings increase with income, at a higher rate than the increase in income.
• Distribution of Income: Savings increase with income inequality, as the rich tend to save more.
• Expectation of Future: Expectation of falling prices increases saving, acting inversely.
• Rate of Interest: A higher interest rate induces more saving, acting inversely.
• Level of Wealth: A lower wealth level leads to lower saving, acting inversely.
• Level of Direct Taxes: Higher direct taxes reduce savings, acting inversely.
• Individual Nature: Saving depends on individual traits, with misers saving more.

Saving Function

• Expresses the functional relationship between saving and income.
• Shows the tendency of households to save at given income levels.

Average Propensity to Save (APS)

• APS is the ratio of total savings (S) to total income (Y), expressed as APS = S/Yd.

Marginal Propensity to Save (MPS)

• MPS is the ratio of the change in saving (S) to the change in income (Yd), expressed as APS = ΔS/ΔYd.

Properties of MPS

• MPS lies between 0 and 1.
• MPS increases with increase in income.
• MPS of the poor is lower than that of the rich.

Relationship Between Consumption and Saving

• Yd = C + S; dividing both sides by Yd gives 1 = APC + APS, meaning APC + APS always equals unity.

Relationship between MPC and MPS

• MPC + MPS = 1, the sum of MPC and MPS is always equal to unity.

Investment

• Investment means an addition to national resources during a current period, such as building new factories, new machines or equipment, or existing stocks of finished goods or raw materials.

Induced Investment

• Investment made with the motive of earning profit in the private sector.
• It depends directly upon profit expectations.
• It is income-elastic.
• If national income goes up, induced investment also goes up.

Autonomous Investment

• Investment made irrespective of income level.
• Usually undertaken by the government sector.
• It is income inelastic and not affected by changes in income level.
• Volume is the same at all levels of income, resulting in a straight autonomous investment curve.

Determinants of Investment

• Profit Expectation: Business investment depends on the profit expectations of business firms.
• Corporate Tax: A decrease in the rate of corporate tax induces investment, acting inversely.
• Level of National Income: An increase in national income induces investment, acting inversely.

Role of Investment in Economic Growth

• Economic growth refers to an increase in the total output of a nation over time.
• Investment plays a crucial role in the economic growth of a nation.
• Private investment in new machinery, equipment, and factories increases the productive capacity of the economy.
• Whenever investment is increased in a country, income and output increase many times more than the increase in investment
• Public investment promotes economic growth directly by developing social overhead and infrastructure.
• Public investment can stimulate economic growth indirectly by providing education, training, and research facilities.
• Public investment reduces disparities in income and wealth and promotes economic growth with social justice.