Lecture 5: Saving and Investment
Saving is that part of income which is not spent on current consumption. The relationship between saving and income is called saving function. Simply put. It becomes much easier to think about user cost as equal to all payments between entrepreneurs in the current period, other than investment in. Income, Savings and Investment What wealth yields called income. Income is possible if wealth is there. Hence wealth is pre-requisite for income. Income may .
Moreover, the accounting equality of saving and investment also implies that the determinants of consumer and entrepreneurial behaviour have to be investigated when the entire economy is temporarily in disequilibrium. Moreover, in the definitional equality of saving and investment, there is absence of the equilibrating variable. Thus, it has been a tool of static analysis. Keynes conceived the functional equality of saving and investment and introduced income as the equilibrating variable.
According to Keynes, in the functional or scheduled sense, there is the saving schedule and investment schedule and the equality between investment and savings is a consequence of changes in the level of income. To him, equality between saving and investment function is an indispensable condition of equilibrium.
Relationship between Saving and Investment | Economics
No level of national income can be sustained without the equality of aggregate saving and aggregate investment. And he stressed the point that income is the functional variable that brings about equality between saving and investment.
In his concept of functional equality of saving and investment, savers and investors react to income variations in such a way that their desire to save and to invest is expected to be harmonised in the very process of these reactions. Thus, if saving exceeds investment that is to say, when investment decreasessaving remaining constant because the saving schedule is a stable function of incomeincome will fall and, therefore, saving will also contract.
Income will continue to fall until the saving out of the lower income is equal to the reduced investment. Similarly, if investment increases, saving remaining constant thus, investment exceeding savingincome will rise until the saving out of the higher income is equal to the increased investment.
It should be noted that when investment exceeds saving, that is, when investment increases, a new equilibrium between saving, and investment will materialise at a higher level of income; and when saving exceeds investment, that is, when investment decreases, the new equilibrium of saving and investment will be at a lower income level.
Hence, Keynes considered shifting equilibrium in his income analysis in terms of saving and investment equality as against the traditional analysis of full employment equilibrium in which investment can be and normally are equal to each other at the point of less than full employment. It mainly depends on dynamic factors such as population growth, territorial expansion, progress of technology and above all, business expectations of the entrepreneur.
Equilibrium Relations between Income, Saving and Investment
Thus, it is unpredictable, unstable and autonomous as against savings which is stable, predictable and induced. Thus, it is fluctuations in investment that cause variations in income which in turn bring about equality between saving and investment. According to Keynes, varying levels of income cannot be sustained in an economy unless the amounts of savings at these levels of income are offset by an equivalent amount of investment.
Thus, Keynesian theory draws the equilibrium relations between income, saving and investment. It stresses that the equilibrium level of income is realised where saving out of income is just equal to the actual amount of investment. This is depicted in Fig. This is the fundamental postulate of Keynesian theory. I1 is the new investment schedule indicating a shift in the I-function due to the forces of certain dynamic factors.
The curve SS is the saving schedule showing how the amount of saving increases with income. But, it is a stable phenomenon and, therefore, usually, there cannot be a shift in its curve. From the diagram it appears that the income is determined by the saving and investment schedules. I thought I would breeze through it quickly since it was all about definitions, but oh no!
Apologies for any incoherence — I was writing as I read, so it is partly a record of my confusion. I went back and changed some things once I had a better idea about what was going on, but I did not have the energy at the end to completely rewrite. Income Income is first defined from the point of view of entrepreneurs. This last element can be calculated in two ways. The first focuses on the value of capital goods sacrificed by using them in production during the period.
This is not simple to calculate, because some value is lost from capital goods whether or not they are used — through obsolescence, for example.Savings and Investments (हिंदी में) - Economic Survey of India 2017-18
It is all about the counterfactual. Depreciation implies a loss of wealth on the part of the entrepreneur. There is an element of this loss of wealth that is not included in user cost: For example, depreciation due to obsolescence or catastrophe.
The rest of the definitions are straightforward: Factor cost equals the amount paid by entrepreneurs to other factors of production unspecified at this point, but presumably being mainly labour.
Prime cost equals factor cost plus user cost. Entrepreneurial income equals output minus prime cost. The income of the rest of the community equals factor cost. Aggregate income equals entrepreneurial income plus the income of the rest of the community, so equals output minus user cost.
Aggregate investment equals [sales between entrepreneurs] minus [user cost]. I have to admit this definition did my head in a little bit, since the definition of user cost includes [payments between entrepreneurs] as a term. So we end up with a statement that aggregate investment equals [the value of capital equipment actually existing at the end of the period] minus [the counterfactual maximum net value that could have been conserved from the previous period if production had not taken place].
This becomes much clearer in the appendix.
Keynes explains that this set of definitions are consistent with the neo classical postulate that marginal income equals marginal factor cost. Without pause for a breath, we move straight into the alternative way of conceptualising the contribution of equipment inherited from the previous period.
Remember Keynes was going to give us two! They are important not from the point of view of aggregate supply, but from the point of view of aggregate demand, because they influence the consumption decisions of entrepreneurs.
Saving Function of Income: Meaning and Relationship between Saving and Income
This is because windfall losses will not affect consumption decisions to the same degree, given that entrepreneurs do not expect them to recur. Therefore he assigns them to the capital account — they are considered mainly to lower wealth rather than income. The line between supplementary cost and windfall loss is thus blurry and psychological — if unexpected windfall losses continually eat into wealth, entrepreneurs are at some point likely to revise their expectations of loss and thus expand what they consider to be supplementary cost — to expect the unexpected.
All I can say is, it is interesting how far institutional and behavioural considerations intrude into a discussion of definitions! So far as I know, everyone is agreed that saving means the excess of income over expenditure on consumption. Thus any doubts about the meaning of saving must arise from doubts about the meaning either of income or of consumption.
Investment is any purchase between entrepreneurs that is not part of user cost.