Consumption, Savings and Investment

Consumption

The main hypothesis of Keynes suggested that our disposable income which can be arrived at by
deducing tax liabilities from gross income influences our level of real consumption. Further explanation
on this is

C = f (Y) where C stands for consumption and Y stands for disposable income.

Keynes also held the view that people tend to enhance their consumption level along with a rise in their
disposable income.

However, the increase in disposable income is greater than the increase in consumption. This hypothesis
can be termed as our marginal propensity to consume and indicates a positive correlation between
these two variables.

This, if our income increases by one unit, our marginal propensity to consume increases by 0.8 units.
Hence the remaining 0.2 units are used for savings.

Y = C + S where Y stands for disposable income, C stands for consumption and S stands for savings.

It is also imperative to note here that propensity to consume and desire to consume are not similar in
nature as the former means effective consumption.

Both objective and subjective factors influence our consumption function. Tax policy, interest rate,
windfall profit or loss and holding of assets are some objective functions whereas subjective ones relate
to motives of foresight, precaution, avarice, and improvement amongst individuals.

Browse more Topics under National Income

The concept of National Income

Measurement of National Income

Economic Growth

Economic Fluctuations
Learn more about National Income here in detail

Savings

In plain words, savings refer to the excess of disposable income over consumption expenditure.

From a national level, the unconsumed part of the entire nation’s income comprising of all its members
can be termed as National Savings.

Total domestic savings, on the other hand, can be defined as the summation of savings of the
government, the business sector, and households.

Some of the biggest determinants of savings are

Income, as saving income ratio holds a proportionate relation with the rise in income. People also have a
tendency of saving the excess part of their income but not the entire bulk.

Distribution of income as the savings process is helped to a great extent by inequality of income
distribution. Our desire to showcase a superior standard of living in comparison to our neighbors often
steers us towards purchasing expensive goods which in turn declines the level of savings.

Psychological or subjective factors such as savings to safeguard ourselves from future insecurity and
uncertainty. The ultimate attitude of people is driven towards savings by their farsightedness. This, in
turn, boosts them up to enjoy a better standard of living both for themselves and their loved ones.

Prevalent financial instruments and rate of interest as a higher rate motivates greater savings.

Investment

Definition of Investment is:

Change in capital stocks or inventories pertaining to a business venture between two different periods
or

Production of fresh capital goods such as plants and equipment.

Relation Between Savings and Investment In Classical System

According to this theory, Savings (S) gets equated with Investment (I) automatically which otherwise
alters the interest rate. If savings exceeds investment, the excess supply of funds brings down the rate of
interest.
This, in turn, reduces savings and increases investment for maintaining equilibrium.

New chapter

What is Inflation? Inflation refers to the rise in the prices of most goods and services of daily or common
use, such as food, clothing, housing, recreation, transport, consumer staples, etc. Inflation measures the
average price change in a basket of commodities and services over time. The opposite and rare fall in
the price index of this basket of items is called ‘deflation’. Inflation is indicative of the decrease in the
purchasing power of a unit of a country’s currency. This is measured in percentage.

What are the effects of Inflation?

The purchasing power of a currency unit decreases as the commodities and services get dearer. This also
impacts the cost of living in a country. When inflation is high, the cost of living gets higher as well, which
ultimately leads to a deceleration in economic growth. A certain level of inflation is required in the
economy to ensure that expenditure is promoted and hoarding money through savings is demotivated.

As money generally loses its value over time, it is important for people to invest the money. Investing
ensures the economic growth of a country.

Who measures Inflation in India?

Inflation is measured by a central government authority, which is in charge of adopting measures to

ensure the smooth running of the economy. In India, the Ministry of Statistics and Programme
Implementation measures inflation.

WATCH VIDEO: Inflation Explained: What is Inflation, Types and Causes?

How is Inflation measured?

In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI
(Consumer Price Index), which measure wholesale and retail-level price changes, respectively. The CPI
calculates the difference in the price of commodities and services such as food, medical care, education,
electronics etc, which Indian consumers buy for use.

On the other hand, the goods or services sold by businesses to smaller businesses for selling further is
captured by the WPI. In India, both WPI (Wholesale Price Index) and CPI (Consumer Price Index) are
used to measure inflation.

What are the main causes of Inflation?

The main causes of inflation in India have been subject to considerable debates and discussions. These
are some of the chief reasons for the increase in prices:

High demand and low production or supply of multiple commodities create a demand-supply gap, which
leads to a hike in prices.

Excess circulation of money leads to inflation as money loses its purchasing power.

With people having more money, they also tend to spend more, which causes increased demand.

Also, note the following pointers:

Spurt in production prices of certain commodities also causes inflation as the price of the final product
increases. This is called cost-push inflation.

Increase in the prices of goods and services is also a factor to consider as the involved labour also
expects and demands more costs/wages to maintain their cost of living. This spirals to further increase
in the prices of goods.

Is Inflation bad for everyone?

Inflation is perceived differently by everyone

Ficakla policy
Fiscal policy, in simple terms, is an estimate of taxation and government spending that impacts the
economy.

Types of fiscal policy

There are two types of fiscal policy:

Expansionary fiscal policy: This policy is designed to boost the economy. It is mostly used in times of high
unemployment and recession. It leads to the government lowering taxes and spending more, or one of
the two. The aim is to stimulate the economy and ensure consumers’ purchasing power does not
weaken.

Contractionary fiscal policy: As the term suggests, this policy is designed to slow economic growth in
case of high inflation. The contractionary fiscal policy raises taxes and cuts spending.

What are the tools of fiscal policy?

There are two key tools of the fiscal policy:

Taxation: Funds in the form of direct and indirect taxes, capital gains from investment, etc, help the
government function. Taxes affect the consumer’s income and changes in consumption lead to changes
in real gross domestic product (GDP).

Government spending: It includes welfare programmes, government salaries, subsidies, infrastructure,

etc. Government spending has the power to raise or lower real GDP, hence it is included as a fiscal policy
tool.

Fiscal policy objectives

Some of the key objectives of fiscal policy are economic stability, price stability, full employment,
optimum allocation of resources, accelerating the rate of economic development, encouraging
investment, and capital formation and growth.

Who sets fiscal policy?

In India, the Union finance minister formulates the fiscal policy.

What is the importance of fiscal policy?

Fiscal policy is a crucial part of the economic framework. In India, it plays a key role in elevating the rate
of capital formation, both in the public and private sectors.

The fiscal policy helps mobilise resources for financing projects. The central theme of fiscal policy
includes development activities like expenditure on railways, infrastructure, etc. Non-development
activities include spending on subsidies, salaries, pensions, etc. It gives incentives to the private sector to
expand its activities.

Fiscal policy aims to minimise income and wealth inequalities. Income tax is charged on all salaried
persons directly proportioned to their income. Likely indirect taxes are also more in the case of semi-
luxury and luxury items than that of necessary consumable items. In this way, the government generates
a good amount of revenue and that also leads to a reduction in wealth inequalities.

A prudent fiscal policy stabilises price and helps control inflation.

Fiscal policy planning gives the larger chunk of funds for regional development so as to achieve a
balanced regional development. It aims to reduce the deficit in the balance of payment.