CONSUMPTION AND SAVING RELATIONSHIP WITH INVESTMENT: . life insurance companies, and commercial bank trust departments as trustees. This paper examined the relationship between savings and credits at Atwima. forecast that present consumption is connected not to present income, but to a .. perfect knowledge on their existence and the usefulness and trust people have. support a positive correlation between saving rates and income. First, there has been no . away from learning about levels of consumption or saving and toward value of stocks, bonds, rights in a trust or estate, cash value of life insurance.
More specifically, we frequently assume that consumption is related to disposable income through the following relationship: A consumption function of this form implies that individuals divide additional income between consumption and saving. We assume autonomous consumption is positive. Households consume something even if their income is zero. If a household has accumulated a lot of wealth in the past or if a household expects its future income to be larger, autonomous consumption will be larger.
It captures both the past and the future. We assume that the marginal propensity to consume is positive. The marginal propensity to consume captures the present; it tells us how changes in current income lead to changes in current consumption.
Consumption increases as current income increases, and the larger the marginal propensity to consume, the more sensitive current spending is to current disposable income. The smaller the marginal propensity to consume, the stronger is the consumption-smoothing effect.
We also assume that the marginal propensity to consume is less than one. The opposite is also true.
At low levels of debt people will consume more and save less. You can likely think of other factors that are unrelated to income that could shift the Consumption and Savings Functions. In general, anything that influences consumption or savings that is NOT disposable income will shift the Functions upward or downward. Any change in disposable income will move you along the Functions. Return to the course in I-Learn and complete the activity that corresponds with this material.
The Interest Rate — Investment Relationship The second component of aggregate expenditures that plays a significant role in our economy is Investment. Remember from our lesson on National Income Accounting that investment only occurs when real capital is created.
Investment is such an important part of our economy because it affects both short-run aggregate demand and long-run economic growth. The dollars spent on the investment have the immediate impact of increasing spending in the current time period.
The Relationship Between Income & Expenditure | serii.info
But because of the nature of investment, it has a long-term impact on the economy as well. If a company buys a new machine, that machine is going to operate, continue to produce, and will have an impact on the productive capacity of the economy for years to come.
This is in contrast to consumption purchases that do not have the same impact. If you buy and eat an apple today, that apple does not continue to provide consumption benefits into the future. Before the investment takes place, firms only know their expected rate of return. Therefore, investment almost always involves some risk. Consider the following scenario. You know that your equipment is slow and outdated.
The Relationship Between Income & Expenditure
You also know that investing in modern computerized printing presses will yield a positive return for your business, but that they will be very expensive. In order to undertake the investment in new equipment, you will have to borrow the money.
Should you borrow the money and buy the new equipment? What will influence you decision? The key variable that will help you to decide whether the investment makes sense for you is the real interest rate that you will have to pay on the loan.
If the expected rate of return in greater than the real interest rate, the investment makes sense. If it is not, then the investment will not be profitable. The real interest rate determines the level of investment, even if you do not have to borrow the money to buy the equipment. The Investment Demand Curve As was illustrated in the example above, the real rate of interest has an impact on determining which investments can be undertaken profitably and which cannot.
Consumption and Saving
The higher the real rate of interest, the fewer investment opportunities will be profitable. This inverse relationship between the real rate of interest and the level of investment is illustrated in the Investment Demand Curve shown below. As with the Consumption Function, there are factors that will shift the entire Investment Demand Curve.