CONSUMPTION, SAVINGS AND INVESTMENT

CONSUMPTION is the amount of money spent on goods and services which yield direct satisfaction. It is the biggest
of the major components of expenditure on output.

FACTORS INFLUENCING CONSUMPTION

 Distribution of national income – when there is a very uneven distribution, income is largely
concentrated in the hands of a very small portion of the population.
 Rate of interest – people tend to save more at a higher interest rate. However, if income-
earning assets yield more incomes then people are encouraged to purchase such assets. Thus,
savings decrease.
 The desire to hold cash – such needs for cash for personal or business reasons reduce consumption and
raise saving.
 Price level – When prices are high (inflation), people spend more amount of money. This decrease saving.
 Population – More people mean more consumption. More people have to buy more goods and services.
 Income – Higher income results to more consumption.
 Taxes – More taxes reduce disposable income. This decreases consumption.
 Attitudes and values – There are individuals who are thrifty or extravagant. Evidently, these factors
influence consumption or saving.

CONSUMPTION FUNCTION
 Is the functional relationship between income and consumption.

Income and Consumption is analyzed in two (2) ways:

 The average propensity to consume (APC) – This is the fraction of all income spent on
consumption
Formula: C
Y
 Marginal Propensity to consume (MPC) – This is the ratio of the increase in the consumption
to the increase in income that caused it.
Formula: ∆C
∆Y if consumption is equal to income, the answer is 1 (based on the formula). If consumption
is less than income, the answer is less than 1. But if consumption is greater than income, then it is
more than 1.

SAVINGS FUNCTION
SAVING – is income not spent or deferred consumption.
• Since the decision on how much income to consume implies a decision on how much to save, a
saving function may be derived with the aid of the consumption function. With no government and
foreign trade sectors, income equals, by definition, consumption C plus saving, S:
• Y=C+S
The Marginal Propensity to Save and the Average Propensity to Save.
 The ratio of the change in savings to the change in income between two periods is the marginal
propensity to save (MPS).
 ΔS/ΔY
 The average propensity to save (APS) on the other hand is the ratio of total savings to total income.
S/ Y

INVESTMENT
 Is expenditure on new capital goods. Capital goods are produced goods which are used to produce other
goods. Investment plays a very vital role in the economy because it creates more employment, production and
consumption. 

DETERMINANTS OF INVESTMENT
 Marginal efficiency of investment (MEI) or returns of investment (ROI).
 INTEREST RATE – high interest rates may discourage investment. If they obtain their funds
from banks, and they expect low ROI, they are reluctant to venture into business

There are other factors which affect favorably the marginal efficiency of investment:

 POPULATION. More people mean more demand or consumption of goods and services. This stimulates further
investment because there are many buyers.
 PRICE LEVEL. Producers are willing to supply more goods and services when prices increase, and there is no
increase in the cost of production. This means higher returns of investment.

 TECHNOLOGY. This reduces unit cost of production and improves quality of output. Obviously, this benefit both
producers and consumers. Lower cost of production encourages producers to produce more. And if they offer
their products at a lower price, this increases the demand for more units of output.

 PEACE AND ORDER. It certainly encourages investment. There is always capital flight whenever the peace and
order situation get worse. Obviously, there is no investment during war, revolution, or rebellion- except those
who are selling arms.

 GOVERNMENT POLICIES. Fair monetary and fiscal policies attract investments. Monetary policies on banks
credit and fiscal policies on taxation are effective tools in inviting more investments.