Income - Consumption and Saving Relationship Assignment Help
There is only a relationship between consumption and savings. It was mentioned that you have an disposable income which you use for your consumption. Marginal Propensity to Consumption (how consumption changes with changing income). MPC = Change in Consumption / Change in Income. For example, if a. MPC is depicted by a consumption line, which is a sloped line created by plotting change in consumption on the vertical "y" axis and change in income on the horizontal This also means that your marginal propensity to save will be relationship between total consumption and gross national income.
To make this clear, lets split measured investment I into these two components: So if people consume less C fallsbut investment in new capital DK stays the same, measured investment rises because firms accumulate inventories of the goods that consumers did not buy DS rises.
But this situation cannot continue, as firms may be losing money. They will cut back on their output, incomes will fall, consumption may fall further, and savings will also fall, cutting back on the initial increase that we started with.
When will this process stop? When firms stop accumulating inventories i. But how can this be? We have assumed that DK stayed the same, and we started with an increase in S?
You have not been paying attention. Each time firms reduce their output to match lower demand, incomes and savings fall. Eventually the initial rise in savings is reversed, because overall income has fallen.
But textbooks make a big thing about aggregate savings equalling investment. If it is just an accounting identity, why is it important? And that is important, for the reasons we have just discussed. It is called the paradox of thrift. A desire by consumers to increase savings ends up just reducing output, and savings do not increase at all. Of course they are still saving more of their income: The Saving Schedule Savings are essentially the portion of your income you don't consume.
If households consume a smaller and smaller proportion of DI as DI increases, then they must be saving a larger and larger proportion.
Consider some recent historical data for the United States. The line that is loosely fitted to these points shows that consumption is directly positively related to disposable income; moreover, households spend most of their income. Propositions of the Law This Law Consists of Three Propositions When aggregate income increases, consumption expenditure will also increase but by a somewhat smaller amount. When income increases, the increment of income will be divided in same proportion between saving and consumption.
Consumption and saving go side by side.
What is not consumed is saved. This is illustrated by a downward shift in the Consumption Function and an upward shift in the Savings Function remember that paying off debt is the same thing as increasing savings. 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. 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.
Saving Function of Income: Meaning and Relationship between Saving and Income
Therefore, investment almost always involves some risk. Consider the following scenario. You know that your equipment is slow and outdated. 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.