Economic determinants of Savings & Investment: Without savings and investment financial market could not exist.

In an economy saving is needed in order to provide a pool of funds for doing investment activities. Therefore, saving and investment is the focal point while discussing about financial markets and saving investment behavior of the economic units (individuals). It is the basic foundation upon which a financial system is built. Before discussing the determinants of savings and investment, there are 3 basic issues related to saving and investment behavior of economic units which need to be analyzed first. These issues are 1. Why do people save? 2. Why do people invest? 3. How do they decide how much to save and how much to invest? There are differences of opinions among the economists regarding this issue which significantly vary from each other. But the most acceptable theory of saving and investment has been given by a prominent economist Irving Fisher. According to his theory : a) Saving and investment behavior is primarily influenced by investment opportunitywhich helps increase the standard of living of the economic units by providing return from that investment in the future. The cost of taking saving opportunities being some sacrifices of consumption in immediate short run. People are induced to take advantages of investment opportunities that have high rate of return. Economic units with preferences of more consumption would go for investment only if the rate of return is higher compared to erosion in the value of money. b) The saving and investment behavior is also influenced by time preference. Economic units generally prefer to consume more at present than using in the future because of time value of money. Patience is a word that works as a brake to build up a pool of saving. On the other hand, impatience which acts as a brake on the laws of investment. The greater the preference for current consumption, the lesser would be volume of savings in the economy. Therefore, actual investment decision of individual is governed by both 1. Impatience to consume 2. Opportunity to invest. Therefore, using financial market economic entities use investment opportunities subjective to time preference, and the given market rate of return to determine their investment qualities of saving, volume of investment, lending and borrowing activities in the financial system. This is actually the theme of Fishers theory regarding the saving investment behavior of economic units.

Determinants of Investment: Investment patterns of economic units are not homogenous. Different category of investment has unique characteristics. Basically, investment has 2 dimensions: 1. Private investment which is purely based on economic motives (profit motive). 2. Public investment which is purely based on social and economic benefits. Private investment usually takes the following: i. ii. iii. iv. Fixed business investment Inventory investment Inventory in residual assets Inventory in consumer durables

Fixed business investment: occurs for 2 reasons: 1. Replacement of old ones which is needed in order to contribute the existing business. 2. Addition to existing business. So business expansion or conclusion is always volatile which is primarily dependent on changing economic conditions. If on good economic conditions, there will be higher demand of company s product, the more would be capital investment required to match with higher demand of product. The direct determinants of investment would be depended on 1) desired stock of capital goods 2) Speed of which actual stock would be adjusted to desired stock of capital. So, therefore, the speed of adjustment will determine the net investment in fixed assets. Secondly, determinants of investment in fixed asset are also dependent on cost of capital to finance the investment. Inventory Investment: Inventory investment is also more volatile than fixed business investment. Inventory investment primarily depends on a) Inventory level to be maintained by firm. Such level is inventory is again influenced by flow of output that the firm expects to produce and sell. As output increases the stock of inventory needed is high. b) Inventory stock also varies positively with the degree of unexpected sales variation. Most companies maintain buffer stock (safety stock) of inventory to meet unexpected higher demand and finally inventory level is also influenced by expected price changes of the materials in the future.

3) Residential Housing: Investment in housing is determined by complex factors of 1. Demand or buyers demand 2. Supply or builders. Primarily, demand for housing is dependent on a) A total population of the country b) Household size c) Family formation d) Choice between old and new houses e) Single or multifamily houses f) Owning vs. renting preference of household etc. All these above factors again will be dependent on: 1) price of houses 2) Income level of households 3) tastes of households Housing demand is also dependent on the cost and availability of housing credit facilities. If cost of the credit is high and credit market is tight, demand for housing will be less; therefore, availability of mortgage credit has a big impact on housing demand vis--vis investment in housing by buyers. Suppliers side: Construction cost in housing is also an important factor that determines the supply of new houses. The more is the cost of labor and material, the higher will be prices of houses which discourage the builders to construct new houses. The other most important determining supply factors are stock of new vacancies in the existing structure, credit facilities available to the builders. Investment in consumer durables: Housholds spend a big amount of money in buying different consumer durables. Some say spending money in consumer durables are consumption goods and they are not investment. but the great majority opine that spending in consumer durables are investment in the sense 1. Durables are not consumed rather their services are consumed and they remain intact till the workable life period. 2. Sometimes consumer durables are used in the business to generate revenues 3. Expenditures on consumer durables are highly volatile and households spend for such items from their savings which is considered as savings move to investment through direct internal financing. 3rdly, determinant of savings analysis of savings behavior of households constitute with lot of complex elements. Many researchers work has been conducted to assess the motives of

savings by savers. But the results are inconclusive i.e. motives of savings by the households is not homogenous by nature. Some possible motives were identified as costs. Some view that people save for their old age. Some other view that people save for lumpy expenditure (large of big) in nature. Others view some economic factors motivates people to save. Finally, some cultural background on level of economic development encourage people to save and others to not. Whatever the reasons are savings are, the level of savings is influenced by 1. Economic conditions of the country which greatly affect the price level and directly the savings capacity of households. 2ndly, classical economics says that rate of interest has a significant influnec on level of household savings. A lower interest rate act as a disincentive among households to save. Thirdly, levies and goldsmith opine that income not the rate of interest is the principal determinant of savings. Fourthly, Milton Friedman has developed Permanent income hypothesis which means that savings decision of households is guided by long run view of income rather than the income of the moment. If people are sure that there is possibility of having permanent income form future investment, people will prone to save.