Chapter 2

Theory of Income, Saving and Investment

2.1 Introduction
After introducing the research topic under study in chapter !, researcher has
reviewed related literature in Chapter 2; both the chapters have discussed the
conceptual framework of saving investment behavior of the households in relation to
their disposable income. Chapter 3 covered socio-economic background of the
population, research methodology applied in conduct of this work and the present
chapter 4 is devoted to theoretical background of the behavioral aspects of society in
general with a view to test those theoretical predictions in the real world of savers and
investors in the selected region.
2.2 Logic behind the theoretisation of the topic
The basic idea of discussing the theoretical predictions is to test the validity of
theoretical predictions in a real world of savers and investors from a small fraction of
sample units from Nashik Municipal Corporation Area during a specific time period to
trace the similarities and differences, if any, from the macroeconomic theory
explaining the relationship between Y (income) C, (consumption) and I (Investment).
The functional relationship between these variables as predicted in economic theory
has been elaborately discussed. Motives behind saving differ fronl individual to
individual depending upon their sex, family responsibilities, occupations they choose,
socio-economic environment around them and so many other factors in such a way that
there is a possibility of actual behavior may differ from theoretical predictions. All
such parameters, other than money income also have to be covered in this study.
It is therefore apt to consider these variables affecting saving-investment
behavior of the individual households and then arrive at an aggregative inference on
the behavior. This chapter shall mainly focus on theoretical predictions and avenues of
saving investment available to the households in general. Actual usage of these
avenues shall be examined on the basis of sample households in chapters 5 and 6 that
follow and the inferences drawn shall be summarized in concluding chapter 7.

24
2.3 Macroeconomic Theory of saving/Investment behavior
Macroeconomic theory predicts a straight forward positive correlation between
incomes (Y), saving (S) and Investment; saving and investment amounts tend to rise
when income increases and fall with a fall in income. However, on micro level, when
income of an individual increases, his consumption increases but not exactly in
proportion to rise in his income but goes on declining as the income increases.
Conversely, savings also increase with a rise in money income but in relation to income
added, rate of saving goes on increasing with every rise in income. In Technical terms,
a change in income leads to less than proportionate change in consumption, which is
called MPC'; marginal propensity to consume AC/AY goes on decreasing as income
increases and vice-versa. Marginal propensity to save^ is a change in saving in response
to a change in income is defined as AS/AY on the other hand shows a positive
relationship with a change in income. MPS goes on increasing with increasing income
and falls as income falls. These theoretical predictions will be tested on the basis of
empirical data in chapters 5 and 6.
2.3.1 Aggregate demand (AD) and Equilibrium Output (EO)

Figure 2.1
Aggregate Demand, Aggregate Supply and Equilibrium Level of Income
'AD=Y

<

Ni N
Aggregate demand is the total amour^pf goods demanded by the people in any economy.
Goods are demanded for consumption (C), investment by private sector (1) Government
Investment (G) and Net Exports (NX)\
AD=C+1 +G+NX
25
The AD can be shown with the help of a figure given below -

In the above given figure 45° line which reads as AD = Y indicates that AD
equals to the level of output at any point on the line. At point E, we find AS Curve and
AD=Y curve intersecting with each other point that OP = AD at any situation prior to
that will indicate that OP < AD and after that OP >AD In other words lU < 0 and lU > 0
respectively as shown in the figure which takes of either inventory falling short of
demand or it is more than the requirement which will force the organizer to pile up
stock of the output. So he will have to cut down the output in order to avoid the losses.
Equilibrium Output and National Income
Identity AD/C+1+G+NX=Y
In the national income accounts, i.e. AD is equal to actual level of output (Y). If
the firms produce output equal to ON] In the figure 0P< AD and of they produce to the
level of 0N2, OP > AD, so we can say that
UI = Y-AD^
Where UI is unplanned inventory both ways and
where Y=AD
It would mean planned inventory.
Consumption Function is the functional relationship between income and consumption
expenditure denoted by (C) and Aggregate Demand (AD). In practice, we will never
find Y and C equal, where Y is Income and C is Consumption.
People earning more Y will consume more than low Y group families. There is a
positive correlation between Y and C. This is described as Consumption Function.
Consumption Function^: - Assuming that Consumption increases with the increase in Y
C=c+CV c>0 0<C<1

When the level of Y is zero c is the minimum amount of consumption required by the
households regardless of what is the level of income and Irom there onwards every
increase in Y, the C also increases.
The coefficient C is termed as 'Marginal Propensity to consume' (MPC) i.e. with the
increase in Y, C also will increase. But in practice, at a later stage we will not find the
increase in Y equaling the increase in C/

26
 2.3.2 Consumption and Saving (C) and (S)
When the Y increase but is not followed by increase in the C by the same
proportion we will have savings (S) as income cane either be spent (C) or saved (S) So
the equation can be
Y- C=S
Where Y is income, C is Consumption and S is savings
Definition of Savings: - Y - C is savings i.e. income minus consumption is
savings. Saving Function
Budget Constraints is putting the above two equations together i.e. Saving Function
equation, where c is autonomous consumption expenditure, even though the income is
zero, that much consumption expenditure is a must.
C=c+CY c>0 0<C<1
And Saving Function equation Y - C = S, we derive of a new equation
Y - C = S = Y - c - C Y = -c + (l - C)Y^
Saving is an increasing function of the levels of income MPC is 1 - C = S is positive, in
other words when the ratio between Y & C is 80: 20, When Y increase by Rs. 100/- C
only increase by Rs. 80/- and the balance Rs. 20/- is savings. Therefore one important
factor of savings is level of Y.
2.3.3 Investment Function (IF)
For a lay man, investment means purchase of shares, bonds etc. but this is not
real investment (inv) this is transfer of assets into another form. According to Keynes,
investment is adding to capital equipment which leads to increase is Y and prod.
Investment is adding to new plant and machinery, construction of dams, public work,
roads building etc. this is making addition of existing stock of goods.
Capital refers to the assets like factories, plant, equipment and inventories i.e.
the existing ones capital is a stock concept and investment is acquisition of real capital
assets during the period of time. If a firm has a capital assets worth 100 Crore in 2010
March and in the following year i.e. March 2011 if the organizer adds 10 Crore the
total capital will be 110 Crore.

27
If 1 is investment, K represent capital and t time period (in year) then
It = Jt — Kt-i

K and 1 arc related to each by net investment, (jross investment is the total
amount spent on new K. on the other side some K wears out every year which is
depreciation. So net I is gross investment minus depreciation which is net addition to
the stock of K to the economy. ]f gross 1 is equal to the depreciation then there is no
addition to the economies K stock, if gross investment is less than depreciation then it is
equal to disinvestment. So gross investment is more than the depreciation it will add to
the net investment.
2.3.4 Types of Investment
There are two Types of investment: Autonomous Investment and Induced
Investment.
Figure 2.2
Autonomous Investment Function

<u 0

>
c

Autonomous Investment - It is the independent of level of Y means not at all

influenced by changes in income but is influential by factors like innovations, inventions,
population growth, labour force, weather changes, war etc. influences the investment.

Induced Investment^ - This is profit or income motivated price, wage and interest
changes will affect profit and will influence induced investment.

Figure 2.3

28
 Change in Induced Investment

r
When Y increases consumption demand increases will be followed by
Autonomous investment. So, 1 =f (Y) this investment is directly related to income and is
income elastic i.e. more the Y more will be the volume of I. The induced investment may
be further divided into two types -
Average Propensity to Invest (API)
Marginal Propensity to Invest (MPI)

Average Propensity to Invest'^ (API) - This is the ratio of investment to Y i.e. I/Y. If Y
is 50 Crore and I is 5 Crore then I/Y will be 5/50 = 0.1
Marginal Propensity to Invest'' (MPI) - This is the ratio of change in I to change in Y i.e.
AI/AY. If I change by 2 Crore and Y changes by 10 Crore then AI/AY will be 2/10 = 0.2
Factors Influencing Investment'^ - There are three important factors which will decide
the Investment by a firm. These are -
The cost of capital asset (k)
Expected rate of returns (r)
Market rate of interest (i)
Keynes has consolidated all the above three into one and named them as
Marginal Efficiency of Capital (MEC)
Marginal Efficiency of Capital (MEC)'^- This is the highest rate of return expected
from an additional K over the cost to be paid for it.

29
If the supply price of K is Rs.20, ()()()/- and the annual yield is Rs. 2000/- The MEC is
2000/20000 X100 = 10 per cent
Thus the MEC is per cent of profit expected from a give I on K asset
Keynes defines MEC as "Equal to the rate of discount which would make the present
value of the series of given by the return expected from K asset during its life equal to
the supply price".
Equation is as follows

Rl R2 Rn
SP= + + +

(1 + i) (1 + i ) ' (1+i)"

Here SP is supply price of K, Rl, R2 and Rpare expected yields annually (years) 1, 2
and n, i is the rate of discount.
Therefore MEC is the rate of discount where equals the two sides of equation.
if the SP of a new K is Rs. 1000 and its life time is 2 years, it is expected to yield Rs. 550/-in
the first year and Rs. 605/- in the second year, its MEC is lOper cent which equals the supply
price to the yield of this K asset.

Thus,

550 605
Supply Price Rs. 1000 + = 500 + 500
(1.10) (1.10)^

In the equation (I) the form

Rl is the Present Value (PV) of K asset

(1+i)
"PV is the present value for the payment to be received in 'future'. It will depend upon Rate of
interest (Rl) at which it is discounted.

30
Suppose we expect Rs. 100/- from a machine in a year's time and the rate of interest is
5 per cent the PV of this machine is

100 100
Rl = = =95.24
(1+i) (1.05)^
After two years, the PV will be
100 100
R2= = =90.70
(1+i) (1.05)^
The PV of a K asset is inversely related to the R.l. The lower the interest rate
higher will be the PV and Vice Versa.
If RI is 5 percent the PV of 100/- will be 95.24,
If Ri is 7 percent the PV of 100/- will be 93.45
IfRl is 10 percent the PV of 100/-will be 90.91
This will help an organizer to take a decision whether to invest or not. If the PV
of K exceeds its cost of buying one should take a decision to invest otherwise not.
The same result can be held by comparing MEC with the market Rl. If MEC of
K is higher, then market RI at which it is borrowed is worth buying K

Figure 2.4
Marginal Efficiency of Capital

0) \
0)
+-• Yi
_c
^ ^^~^~^.___ MEC
o
01
4-*
K

n Ki K,

The MEC Curve is negatively sloped. This indicates that higher the MEC lower
the K stock. This is due to the law of diminishing return in production. In other words
as there is a decrease in RI Stock the K will increase.

31
 2.3.5 Marginal Efficiency of Investment (MEl) '^
Marginal Efficiency of Investment is tlie rate of return expected from aa given I
on a K asset after covering all its costs, expect the Rl, lower the Rl higher will be the I
and Vice versa. So the MEI Curve also slopes downward from left to the right as
shown in the figure given below -
Figure 2.5 A and B
Different slopes of MEC,curves

R
01 01 R ^-_^__^
^
k-
OJ Rl — ~~^^ ——~-^
_c
Rl c ^ ^——
1 o ^^^-^~. M
o N^MEI OJ
*-*
(0
0 1 X en n 2

investment Fig. B
Investment Fig. A

Fig. A indicates the relationship between MEI and the rale of interest is less
elastic and fig. B indicates more elastic.
Sometimes when there is reduced I due to heavy profits then even without a
change in i, I will increase as shown in the figure below-Figure 4.5 Y

01

o
oi
nj
cr

2.3.6 Relation between MEC and MEI -

The MEC shows the rate of return of K on existing stock. MEI shows the return
on units of capital over and above the existing stock of K. MEC is the stock concept

32
 while MEI is tiie flow concept. MEC determines the optimum stock of K at each level
of interest rate. ME! determines the net investment of the economy at each rate of
interest; Factors affected Induced Investment other than rate of interest.
1) Uncertainty: like general mode of business community, rumors, technical
development, political events etc.
2) Existing Stock of Capital Goods: if it is large it would discourage the investors from
entering the market. Induced Investment will not take place if there is excess or idle
capacity in the existing stock of the K asset. If the plant is working to the full capacity
only then the induced investment will take place
3) I^v^/o/y.-ifthe Y increases in both wages and for other factors of production i.e. Rent,
wage and Rl then there will be excess demand and will be followed by induced
investment.
4) Consumer Demand: if the Consumer Demand increases due to the above mentioned
point no. 3, it will also increase the inducted 1 (Investment).
5) Inventions and Innovations: Technological inventions will decrease the cost of MEC
will increase will be followed by increase in induced I. The same is true with the
innovations which will open up in the new areas like transport, roads, housing etc.
6) New product: if the sales prospect of a new product is high and so are high revenues
the MEC will be high and will encourage MEI i.e. induced investment.
7) Growth of Population: More population will mean more AD so more induced
investment.
8) Government Policies: Changes in fiscal policies will have a positive impact on the
induced Investment i.e. if taxes are lower I will be also cheap power, credit facilities
will increase I
9) Political Climate : stability in the political atmosphere will always have an positive
impact on induced I
2.3.7 GDP and CDS relationship'^
Theoretically speaking, there has to be positive relationship between gross
domestic product and gross domestic saving because as the level of income increases,
marginal propensity to consume falls progressively with a corresponding rise in marginal
propensity to save. To test the validity of this theoretical prediction, official data on GDP

33
and GDS for the period 2004-05 to 2012-13 at factor cost as well as at market prices at
current market prices has been tested in table 2.1 given below:
Table 2.1
Gross Domestic Product At market prices. Factor price at current prices. And
Gross Domestic Saving
GDP FC,
GDP at Saving Private
Current. Gross Savings of
Sr. Financial Current Financial In Corporate
Prices Domestic Household
No. Year Prices saving Physical Sector
Rs. Saving sector
Rs. Crore. Assets saving
Crore
3,242,209 2,971.464 1,050,703 763,685 327,956 435,729 212,519
1 2004-05
(0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0)
3.693,369 3,390,503 1,235,150 868,988 438.331 430,657 277,208
2 2005-06
(13.9) (14.1) (17.6) (13.8) (33.7) (-1.2) (30.4)
4,294,706 3,953,276 1,485,908 994,396 484,256 510,140 338.584
3 2006-07
(16.3) (16.6) (20.3) (14.4) (10.5) (18.5) (1.0)
4,987,090 4,582,086 1,836,332 1,118.347 580.210 538,137 469,023
4 2007-08
(16.1) (15.9) (23.6) (12.5) (19.8) (5.5) (38.5)
5,630,063 5,303,566 1,802,619 1,330,872 571,026 759,846 417,467
5 2008-09
(12.9) (15.7) (-1.8) (19.0) (-1.6) (41.2) (2.0)
6,477,827 6,108,903 2,182,338 1,630,799 774,753 856,046 540,955
6 2009-10
(15.1) (15.2) (21.1) (22.5) (35.7) (12.7) (29.6)
7,795,313 7,248,860 2,621.742 1,800.174 773.859 1,026.315 620,300
7 2010-11
(20.3) (18.7) (20.1) (10.4) (-0.1) (19.9) (3.0)
8,974,947 8,391,691 2,824,460 2,054,737 632,196 1 1.422,541 658,428
8 2011-12
(15.1) (15.8) (7.7) (14.1) (-18.3) ! (38.6) (6.1)
10,028,118 9,388,876 3,043,474 2,212,414 717,131 1,495.283 713,141
9 2012-13
(11.7) (11.9) (7.8) (7.7) (13.4) (5.1) (4.0)
Source: Compiled from official sources of Government of India, financial reports of the
respective years.
The table given above gives figures of the gross domestic product, gross domestic
savings (GDS) classified fiirther into few specific sub-groups of saving from 2004-05 to
2012-13. The year 2004-05 is considered as base year with the index value as 100. During
the year 2005-06, GDP at current prices and GDP at factor cost increased by 13.9 per cent
and 14.1 per cent when GDS increased by 17.6 percent. This supports the theoretical
prediction that there is surely a positive relationship between GDP and GDS, however, the
relationship is not necessarily proportionate, GDS rises at a higher rate than GDP. The
same tendency is observed during the period from 2005-06 to 2007-08 Further there was an
increase in the GDS was increased to 20.3 percent. During the year 2007-08 the GDS
increased further to 23.6 percent. Unexpectedly the GDS came down abruptly to -1.8
percent and again during the year 2009-10 there was a sharp increase in the GDS to 21.1
percent but however this less than 2007-08. A further reduction in GDS was noticed during
the year 2010-11 to 20.1 percent. During the next two years i.e. 2011-12 and

34
2012-13 a sharp drop in the GDS was noticed by almost three times, taking the GDS to
7.7 percent and 7.8 percent respectively.
In the same table we notice the Gross Domestic product (GDP) at current prices. The
trend which was noticed regarding the GDS is also noticed in GDP keeping the base year
as 2004-05 when the GDP at current prices was 0.0 percent. It increased to 13.9 percent in
the year 2005-06. A further increase was noticed in the year 2006-07 when it went up to
16.3 percent. A marginal drop was noticed in the year 2007-08 to 16.1 percent. During the
year 2008-09 the GDS was -1.8 percent but the GDP was 12.9 percent lesser than the
previous year. During the next two years i.e. 2009-10 and 2010-11 an increase in the GDP
was noticed to 15.1 percent and 20.3 percent respectively. But during the next two years
i.e. 2011-12 and 2012-13 it reduced to 15.1 percent and 11.7 percent respectively.
We also notice in the table given above the figures regarding the GDP at factor cost at
current prices during the year 2004-05 it was 0.0 percent increase to 14.1 percent in the
year 2005-06. In the year 2006-07 a further increase in GDP at factor cost was noticed
as 16.6 percent but during the next three consecutive years i.e. 2007-08, 2008-09 and
2009-10 a reduction in the GDP at factor cost was visible as 15.9 percent. 15.7 percent
and 15.2 percent respectively. In the year 2010-11 this increased to 18.7 percent. We
notice that both GDP at current prices and GDP at factor cost increased over the
previous year i.e. 2009-10. And during the last two years i.e. 2011-12 and 2012-13 the
GDP at factor cost reduced to 15.8 percent and 11.9 percent respectively.
My area of study is regarding household savings. This table also gives the
information about household savings. The total household savings as par the base year
2004-05 is 0.0 percent. During the year 2005-06 il was 13.8 percent. In the year 2006-
07 this increase to 14.4 percent and then during the year 2007-08 household sector
savings reduced to 12.5 percent and increase in the household savings was noticed in
the year 2008-09 to 19.0 percent. A further increase was seen in the year 2009-10 to
22.5 percent. Surprisingly the household savings in the next year i.e. 2010-11 dropped
by more than half to 10.4 percent. During the year 2011-12 an increase was noticed as
14.1 percent. But again in the year 2012-13 the household sectors savings recorded by
almost half over the previous year as 7.7 percent.

35
 The household sector savings is normally divided into two as financial savings
and savings in form of physical assets. Both the physical and financial savings in the
base year 2004-05 was 0.0 percent. The financial savings during the year 2055-06 was
33.7 percent and savings in physical assets was -1.2 percent. During the year 2006-07
physical savings dropped to 10.5 percent but a sharp increase was noticed in the same
year as 18.5 percent over the previous year. During the period 2007-08 financial
savings was 19.8 percent and 5.5 percent as savings in physical assets. In the year
2008-09 financial savings dropped down considerably to -1.6 percent. But the savings
in physical assets recorded abrupt growth to 41.2 percent. Then again there was a shift
in the savings in financial forms as 35.7 percent and physical savings as 12.7 percent.
In the year 2010-financial savings dropped down to -0.1 percent and physical savings
increased to 19.9 percent over the previous year. In the year 2011-12 financial savings
showed a negative growth -18.3 percent but the physical savings was almost double to
38.6 percent over the previous year. And finally in the year 2012-13 financial savings
showed a positive trend as 13.4 percent and physical savings as 5.1 percent.
It can be noticed over here that the households take a decision to shift their savings
from financial savings to savings in physical assets forms considering the market
fluctuations on rate of interest, risk involved, attractive schemes declared by various
players in the market and change in the government monetary and fiscal policies.
In the table given above we also notice the private sector savings. In the year 2004-05 it
was 0.0 percent went up by 30 times to 30.4 percent. But it reduced by almost the same
proportion in the year 2006-07 to I.O percent. Again a sharp increase was noticed in the
year 2007-08 by almost 38.5 percent during the period 2007-08. Then in the year 2008-
09 it came down to 2.0 percent and in 2009-10 the private sector savings increased to
29.6 percent. And the next three years i.e. 2010-11, 2011-12 and 2012-13 the private
corporate sector savings were in single digits as 3.0 percent, 6.1 percent and 4.0 percent
respectively.
Various Committees formed to Study the Savings of Household
There are three committees formed so far to study the savings made by the households
(H.H). They are a) Raj Committee b) Chelliah Committee c) High Level Committee
(HLC).

36
 Other factors responsible to decide the rate of S: - a) Level of Y b) rate of
interest, size of family. Larger is the size of family, lesser will be the amount of S d)
Interval of Y earnings: - Smaller the intervals between earnings Y', smaller will be the
per cent of savings of the families. Bigger the intervals larger will be the per cent of S.
e) Level of Inflation in the economy, higher the per cent of inflation and longer the
period it continues in the economy smaller will be the per cent of savings, f)
Speculations in the 11.H speculate a drop in price in future they will save today to be
spent at latter day. g) Health conditions in the family if the in the houses is very stable
then the quantum of the savings would be more, h) Various agents: - If various agents
will appoint agents like postal agents, LlC agents, M.F agents, daily collection agents,
etc. they will encourage in good amount of savings even for small amounts, i) Price of
precious metals :- If the prices of gold, silver, platinum, diamond is high the rate of
savings will be high j) Composition of the family:- if the parents have more female
members than the male members then the rate of savings will be more so that the
couple can take care of themselves with out-taking help of anyone
2.4 Avenues for Savings
There are a number of sources available today unlike in the past previously
people and to save only in land, building, Gold, Silver, etc. Today number of avenues
are opened like Bank of All forms, PSB, Private Banks, Cooperative Banks,
Cooperative credit societies, Post offices recently have been given the permission to
start to bank even big industrial house with some conditions applicable are allowed to
establish banks, chit funds, mutual funds, LIC, precious metals, govt, bonds, land,
building, Capital market, Money market.
There are various schemes adopted by various agencies to attract savings like:
Banks have various types of deposits in the form of savings a/c, F.D a/c, R.D a/c
which suit the requirement of all the classes of all the society i.e. high Y groups and
low Y groups.
Post Offices also provide R.D facility to their customers, F.D schemes or M/S
scheme, savings a/c, various certificates like NSC, KVP, etc.

37
 Capital Market is useful to those people who have large volumes of money and
who are prepared to take risk. They may not want safe and sure returns. The I is either
long term or of a permanent time.
Money Market is helpful to the small investors who would like to I for short
terms are prepared to take small amount of risk.
Mutual Funds. - are meant for the people who are not ready to take risk to enter
the capital markets but do have investable funds in small amounts. Over year they can
get some assured returns and also incur some amount of risk. M.F do collect the money
normally for the period of 10 years but the customer can withdraw his money after a
lack in period of 3 years
Gold and Silver. - These metals have highest amount of liquidity and also they
give good returns on investment/savings.
Govt, bonds: - They are the most trustworthy forms of I so the people will like
to put their savings in govt, bonds. They also give some returns on maturity.
Chit Funds: - There are forms of savings normally to a small group which come
together every month and save a part of their Y which can be as small as RS.lOO/- p.m.
and get back their savings at the end of 12months, 24 months, etc.
Land and building: - Due to the huge population always demand for land and
building exceeds the supply this always increase the price so people will want to invest
in this.
Life Policies: - This type of insurance as both public and private are available to
those people who will want to invest for return and also will want to cover up their life
risks.
2.4.1 Reasons for the Savings
There can be two important reasons that can be pointed out for savings by
households. They are safety about the future and return of an investment in form of Rl
to compensate with the inflation prevailing in the economy when people can't have
good mobility, physical strength work in old days as they can in younger days. This is
called as the savings for the rainy days.

38
The H.M factor plays a very important role in generation of savings in the economy. IILC was
of the opinion that estimation of households, S is to be collected from number of sources
including Apex Body.
The HLC focused on addressing the following TOR while dealing with H.l I with H.H sec S.

1. To examine the possibility of estimating H.H savings through integrated Y and

expenditure surveys.
2. in the light of higher growth path of the economy to undertake the review of the available
estimates of H.H savings and 1 in economy.
3. To study if vigorous financial deepening in the economy is getting densely reflected in
the estimates of financial savings and suggests improvements where ever needed.
4. To examine the flexibility of arriving at separate estimates for pure house hold,
entrepreneurs and unincorporated bodies through a suitable method
5. To examine the empirical method and procedure used in the estimates based on the flow
of funds and suggest improvements.
6. To suggest new database if any.
Approach Adopted By HLC to Examine the Estimation of Households in Saving The
worksheet approach where every item is examined with respect to:
1. Sources of data and underlined conceptual issue.
II. Methodology adopted for each parameter along with limitation and problem.
TTT. Prescribed procedure for estimation Identified in data and methodology.
The present practice is either the data on various Households' is obtained from induction
institutions estimated HLCs was of the opinion that efforts should be made to keep the actual
methodological practice in alignment with description with National Accounts Statistics
(NAS). All the apex bodies were directed to examine the Households from the following
Points. Identification of the database used.
Methodology prescribed in practice used.
Validation of data
Comment on changes required in procedure.
Discussions in meeting
Recommendations

39
 2.5 Conceptual and Methodological Issues in Currency Held by Households
Currency is held by households and also by various agencies. At present a fixed
ratio of 93.0pcr cent of the currency with public is held by public is used as
households. There is a need to reexamine this periodically.
Raj Committee Recommendations - The amount of currency held by households
we have to subtract currency held by private corporate business, co-operative institutions,
Govt, undulating and Govt, treasurers and local authorities from the total currency.
The Chelliah Committee Recommendations - The Flow of Funds data reveals
that the currency held by households is estimated to be 93per cent of currency held
with public which is obtained from monetary data for the last data of each financial
year, fhe Chelliah Committee recommended that where the data is not available an
average ration for the past three years should be applied.
Identification of Data Source - The data of total currency is got from DEAP, RBI
which is used to estimate cash holdings with households Methodology prescribed -

Flousehoid Savings is the form of currency is derived by misusing the currency

held by Pvt. Corporate bodies, public sector enterprises from the total currency with
public. The data of the total currency can be available in the R.B.I. Bulletin.
Discussions in the HLC Meetings - Two issues were mainly discussed
i. Including currency as a part of households' holding
ii. Presently 93 per cent of currency issued is with the public as households' holdings
On the first issue HLC stated that out of the households Currency holdings part
may be used for present or future spending or may be used for speculation purpose
they cannot be a part of households.
On the second issue, the currency ratio of households is currency as proportion
of cun-ency with public used as 93 per cent and the ratio was decided in 1985-86. So
there is a need to revise the data to gel the amount of savings with households as with
the financial inventions the ratio can be of lower size.
HLC noted that to understand the amount of household saving, the census studies should be
carried out of least once in five years as same companies grow and closure of

camp will take place Th- 15092

40
 There are a large number of credit societies which arc scattered throughout; this
situation is likely to give upward trend of household saving
The use of credit and debit cards ATM's have put down the need of cash
holdings so the ratio also will be at a lower side. Now a day, a lot of electronic transfer
of funds takes place. There may be lesser use of cash holdings by households. There is
a practice of reporting the data of flow of funds for all the sectors in some countries
U.K., USA, Germany, France etc. there are practice for selling the flow of funds
usually a fixed proportion is adopted.
There is no specific methodology used to find out the amount of savings by
households accurately as lot of time and money will be involved in understanding that.
So the latest flow of fund data may be used i.e. up to 2000-01 which exhibits an
average of 93 per cent for house hold cash holdings.
The table given below shows that average households Currency holdings during
the three years shows an average of 95 per cent of currency with public. [Table 6.4
from page 106 of RBI Bulletin April 2009]
2.5.1 Recommendation of HLC - The committee recommends that currency
held by households as per the latest flow of funds data be considered for the purpose of
estimating the currency component for the households' sector savings.
Bank Deposits - Various banks like the commercial banks, co-operative banks,
credit societies, cooperative non credit societies, private banks etc. are the main source
of household savings.
Raj Committee - There is a need to classify the ownership of deposit so that a
clearer picture of the sub categories called others including unclassified owned as
much as 40.7per cent and 32.1 per cent of commercial band deposit. In March 1976
and 1978 respectively and further clarity would be got if form households and nonfarm
households and unincorporated
2.5.2 Chelliah Committee Recommendations
For estimating the savings of households in commercial banks, aggregated
deposits with scheduled and non-scheduled commercial banks are added. The data of
scheduled commercial banks can be obtained from RBI Bulletin which is collected on
last day of March each year and of non-scheduled, every Friday of March. The

41
 aggregated is further classified into current savings and FD obtained from ex statement.
Tliereafter, N'. R. I. deposits inclusive of interests are deducted to obtain domestic
deposits.
The Committee made the following observations regarding BSR-4 Survey. The
survey on ownership of deposits of commercial banks which was biennial is made on
annual basis now.
Identification Of Data The data is obtained from division of money and banking,
DEAP, RBI Form X data available from identification of data. Foreign currency
obtained from N.R deposits, obtained from division of international finance department
of the RBI. BSR Survey on composition of ownership pattern of scheduled commercial
banks deposits DSIM, R.B.I.
2.5.3 Methodology
The share of household deposits in current, savings and FD is estimated on basis
of RBI annual survey undertaken each year. The households consist of: Individual
included (HUF)
Trust association clubs
Proprietary and partnership concerns
Educational institutions
Religious institutions
Others
Discussion in HLC Meetings

The HLC noted that the data of SCBs are based on survey of composition and
ownership of deposits conducted as part of BSR system (BSR4). A stratified sampling
design is used for selection of branch banks. AH the SCBs are first stratified stale wise
population groups like: Rural, Semi urban. Urban and Metropolitan.

Five Bank Groups are:

I. SB I and other associate
banks II. Nationalized Banks
III. RRBs
IV. Other SCBs i.e. Pvt. Sector banks.

42
V. Foreign banks
After that, each stratum is divided into these groups
1. Up to 25 Crore.
II. 25 to 100 Crore.
III.100 Crore and above
To form the ultimate strata all branches having deposits of 500 Crore and above
are included in sample with currently. From the other deposit classes, sample is drawn
using the (SRS) Simple Random Sampling Technique.
By making use of above procedure sample for March 2006 consisting of 10531
branches of SCBs out of total 68681 branches reporting as per quarterly BSR-7 return
as March 31 2006 2759 branches each of Rs. 100 Crore deposits were chosen. Phese
branches accounted for 44.8 per cent of deposits, 7772 branches accounted for 7.8 per
cent deposits and 10531 branches covered 52.6 per cent of deposits. In case of states of
Delhi and Maharashtra, where large branches with deposits above 100 Crore, at
present, the share of deposits is higher than the population due to branches being
included in sample within small states it is the opposite case.
The HLC recommended that NGOs should be treated as a separate category.
The further it is also suggested that bifurcation of NRE deposits between savings and
FDs is available with the monetary policy department of RBI. There is no need to apply
a historical ratio to bifurcate this FCNR deposits can be taken as FDs.
2.5.4 Recommendations
RBIs annual survey on composition and ownership pattern of SCB bank
deposits needs to be looked at for further refinement in terms of Representative nature
of sample
Margin of error
Reduction of time lag
The HLC recommended that NGOs, SHG, which are gained a good amount of
importance today that they should be treated as a separate category under H.H
There is a need to standardize the database for the estimation of households by using
consistently the March 31 figures in place of last reporting Friday of March which is
available for every year with a time lag of 3-4 months.

43
Deposits with Cooperative Banks and Credit Societies
2.5.5 Raj Committee This committee has not given any specific
recommendations on Chelliah Committee. The data on assets and liabilities of all the
cooperative societies are published in statistical statements relating to cooperative
moments in India
Part 1 - Credit Societies
Part II -Non Credit Societies by NABARD.
Deposits with primary societies are taken as households deposits while in the
case of cooperative and other credit societies the households deposits are estimated
using information available on ownership pattern which furnishes details of such
deposits. Individual deposits are treated as household deposits and in the same fashion
for non credit societies. The deposits are derived on the basis of households' shares in
total deposits. The flow of such deposits during a year represent house hold sector in
such deposits. The data of non-credit societies the estimation of households' Savings is
worked out on the basis of available data. The data of households 5 is got from
Statistical Statement relating to Co-operative moment in India (NABARD). This is
estimated on past trends in growth rate or some other judgmental basis where of non
availability of those publications on time. Normally the time lag is 6 to 7 months. Due
to this there is a small deviation from the procedure that is prescribed.
2.5.6 Discussions in the HLC Meeting
The HLC had no problems using the data received other than time lag problems.
According to NABARD the data for the "Statistical Statement relating to the Co-
operative Movement in India" is compiled on the basis of audited statements submitted
by SCB'S, DCCB's, SCARDB's and ICB's. They all are compiled and forwarded by
respective agencies and the state level and national level. Consolidations fare each
agency is done by NABARD. The data of primary credit societies and all non credit
societies
The data is consolidated at the state level RCS i.e. Register of Cooperative
Societies, Functional Register, Concerned directorates of states and finally the national
level Consolidation is done by (NABARD) for each category of society.

44
 There are total of 51 forms used to collect the data from various agencies like
SCB's/DCB's/lCB's/SCARDB's/RCB's on the recommendation of review along with the
guideline to fill up the format .IlLC was of the opinion that a effective & timely collection
and competition of Cooperative statistics would only be possible if all the cooperatives will
submit their report in one single format annually The audit of societies should be done on
time. HLC also suggested that provisional data should be submitted without delay with
allowing some Correlation of a later date i.e. after final audit report.
At the bankers institute NABARD organized a meeting with RGB's held at
BIRD "Banker Institute of Rural Development". The Chairman in the meeting kept on
records that statistical data base of the co-operative Sector is very important for
NABARD and RBI and Government and demanded a reduction in the time lag by not
more than one year. In order to reduce time lag Dr. Shetty who was representing HLC
recommended an action plan at RCB's should depute suitable staff for the posting of
data. It is being observed that there is a pattern of heterogeneity in the pattern of
receipts of audited statements. In such cases also the time lag for submitting the reports
should not be more than a year. The HLC is the opinion that NABARD may supply
provisional estimate based on the test receipt position of co-operative data from RCB's
every year to RBI for households' Saving and FOF's and CSO's for NI accounting as
the estimates are to be prepared year after year in a time bound manner.
2.5.7 Recommendations
HLC recommended that NABARD should be involved is providing a projection
to households' 'Savings in Co-operative Banks & Credit Society's to get around the
problem of considerable time lag in the publication such as " Statistical statement "
relating to Co-operative movement in India for both , Credit & Non-credit Societies .
Efforts should be taken to reduce the time lag.
NABARD should continue to play an important role as an open agency for the
Co-operative Sector & provide Data for the compilation of National Accounts. Savings
Estimate &. FOF Accounts in so far as the Co-operative Sector is concerned, the
NABARD should collaborate with National Federation of State Co-operative Banks
(NAFSCOB)

45
 (1) Deposits with Co-operative Non-Credit Societies:
The same problem as seen in the earlier case is also found here i.e. time lag &
non availability of publications on time. So past trends have to be used.
Discussions in the IILS meeting were also in time with that of the previous, i.e.
for Co-operative Banks & Credit Societies so the same recommendations should be
applied.
(2) Non-Banking Deposits
The Non-Banking Co-operative Financial &Non-Financial Government &Non-
Government Companies & Electricity Boards accept public deposits as a part of their
business.
Raj Committee : This is an important area of households' Saving as they give
higher returns therefore it is imperative that steps are taken in the RBI to ensure
adequate coverage of Non-banking Companies in the survey of deposits. Recently fully
Government own Public Sector Companies started accepting deposits from the public.
So Raj Committee recommended that RBI also should cover such type of households
saving, Security Deposits kept with various improvement fruits, Housing Boards,
Electricity Boards etc. They should be treated as Household savings.
Chelliah Committee: This Committee also wanted the security Deposits kept
with Telephone Companies should be brought under the preview of households' saving
The data source can be collected from Public deposit data in respect to Financial
Companies are obtained from the Department of Non-Banking Supervisions (DNBS),
RBI, Housing Financial Companies from NHB, etc. Methodology prescribed:

The NBFIS are classified into:

Registered & Regulated by RBI
Non registered with RBI, but RBI gives directives regarding Deposit
acceptance Exempted from RBI regulations
Under Category (I) Loan Companies, Investment Companies, Equipment using
Companies, Higher Purchase Finance Companies
Under Category (II) Mutual Deposit Finance Companies like NIDHIS &
Miscellaneous NBF, Chit fund Companies are included

46
 Under Category (III) Insurance Companies, Stock Exchanges, Stock Brokers,
Merchant Banking, Housing & Micro-finance Companies arc included
On the basis of DNBS survey, the ratio of Government & Non-Oovernment,
Non-financial Companies is calculated & the ratio is applied to Non-government Non-
fmancial Companies. The share of households' saving in Total Security Deposits is
worked out by allocating it on the basis of households share in total consumption of
electricity.
The methodology for Non-banking Financial Companies is the same as per the
prescription. Studies on finance of Public Limited Companies & Private Limited
Companies by DSIM, RBI are not available on time. There is one additional problem
that blow-up factor for arriving at the global figures from sample has not been
available. With DISM for recent years so data is estimated on the basis of last 3 years
& past trends in case with Electricity Boards
Trend and Composition of Gross Domestic Saving'^
The Gross Domestic Saving (GDS) rate has exhibited a generally upward trend
since the 1950's with some intermittent sharp escalations, notably over the period
2002-03 to 2007-08. The composition of GDS shows the continued predominance of
household sector saving (at around 70 percent), notwithstanding a reduction in its share
from the peak attained in 200-02 (over 94 percent).
After the 1990-91, the share of the private corporate sector in SGS has exceeded
that of the public sector, in contrast to the trends prevailing earlier. These trends are
explained in subsequent sub-sections.
Contrasting Movements in the Saving of the Household, Private Corporate and
Public Sector:-
The rapidly evolving macroeconomic and policy environment has been associated
with contrasting movements in the rates of savings of the household, private corporate and
in the trends in the savings rates of the three sectors. While household savings has
continued to account for the predominant share of gross domestic savings over the years,
the household savings rate which has generally moved upwards at an increasing pace till
2003-04, generally leveled off thereafter at around 23 percent. In contrast, the private
corporate sector saving rate which had remained nearly stable at around 2 percent up to

47
the 1980's picked up subsequently and increased siiarpiy after 2002-03 to over 9
percent by 2007-08, on the back of improved corporate profitability; the private
corporate sector savings rate has hovered around 8 percent since then. The private
corporate sector has remained vibrant and has benefitted from increasing consumption
and investment demand arising out of consistently high economic growth. With robust
sales growth improved productivity and healthy profit margin, corporate recorded good
growth in profits which translated into higher saving. The public savings rate turned
positive in 2003-04 and peaked at around 5 percent in 2007-08 largely reflecting the
decline in public sector saving occurred in 2008-09 largely on account of the Sixth Pay
Commission arrear payouts and fiscal stimulus measures, which persisted in 2009-10
with the public sector savings rate declining further to 0.2 percent.
It is noteworthy in this context that both public sector savings and private
corporate sector savings improved substantially during 2000s is even as household
savings rate plateaued somewhat.
Trends in Household Sector Savings-Rate and composition:
A striking feature of the 2000s is the general leveling off of the household
savings rate at about 23 percent from around the middle of the decade in contrast to the
upwards movement in the previous year (Table 3). Moreover, this leveling off occurred
even as the economy generally cruised along a high growth trajectory (Barring a brief
hiccup in 2008-09). The factors underlying the stability in the household savings rate
are discussed next.
Total saving of the households comprises financial savings and physical
savings. Financial savings are treated on a net basis i.e. household's (change in gross)
financial assets less their (change in gross) financial liabilities. It is evident from table
2.2 that while physical savings of the households increased.

48
 Table 2.2
Average Trends in Household Savings As percent of GDP at current market prices
Changes in Net
Changes in Change in Change in
Financial Total
Gross Gross Financial Physical
Period Assets Household
Financial Liabilities Assets
(NFA) (2-3) Savings (4+5)
Assets (GFA) (GFL) (HPA)
1 2 3 4 5 6
1970s 6.0 1.5 4.5 7.3 11.8
1980s 8.9 2.4 6.5 7.2 113.7
1990s 11.2 1.6 9.6 8.2 17.9
2000s 14.2 3.4 10.8 12.3 23.2
2000-05 12.8 2.4 10.3 12.9 23.1
2005-11 15.5 4.2 11.3 12.2 23.5

Sharply during the first half of 2000s, the pace of increase in gross financial assets
as well as gross financial liabilities slowed down. With the net financial savings rate
resultantly showing a modest increase, most of the overall increase in the households'
savings during the first half of the 2000s was on account of physical savings. The
household sector's preference for savings in the form of physical assets since 2000-01
could be attributed partly to the robust economic growth as well as rising availability of
credit to meet financing needs of the household sector.
During the second half of the decade, even though the gross financial savings
(assets) and gross financial liabilities of the households increased sharply, the increase
in net financial savings rate remained modest.
At the same time, the rate of physical savings declined partly in response to the
tightening in credit norms, offsetting the increase in the financial savings rate.
Consequently, the household's overall savings rate remained largely unchanged (at
around 23 percent) since mid-2000s.
Since the 1970s the allocation of household savings between financial assets
and physical assets had been progressively moving in favour of the former, with the
notable exception of the first half of the 2000s. The allocation became almost evenly
balanced during the second half of the 2000s.

49
 The extent to which household physical assets were funded through loans and
advances increased sharply during 2004-05 to 2006-07, coinciding with the high
growth phase and real estate boom. Subsequently, this ratio has declined.
Evolving Structure of Households' Gross Financial Savings:
The composition of (changes in) the gross financial assets of households has
also changed substantially over the years (Table 2.3)
• The share of currency has declined to around 11 percent during 2005-10 as
compared with 14 percent in the 1970s reflective of the spread of banking facilities,
the declining share of agriculture in GDP and moderation in inflation.
Table 2.3
Composition of (Changes in) Gross Financial Assets

•0
3
c
Ii 111^ii o
i - i*c
" _0-D
^
= III ° us
* T. i£
«s

> ^ 5 ft C ^

o.s <
1 2 3 4 6 7 8 9 10 11

1970s 13.9 45.6 3.0 9.0 19.6 4.2 1.5 0.5 2.7 100.00

1980s 11.9 40.3 4.6 7.5 17.5 11.1 3.9 2.2 0,9 100.0

1990s 10.3 34.7 6.8 10.1 18.8 9.5 7.0 3.8 -1.0 100.0

2000s ^9.6 44.7 1.3 17.4 12!4^" " Ti.i 4.1 -0.5 0.0" ioo,o"

1)2000-05 8.9 37.8 2.0 14.7 15.1 19.5 2.8 -0.9 0.0 100.0

ii) 2005-
10.7 49.9 1.7 19.9 10.3 3.5 4.3 -0.2 0.4 100.0
n

Bank deposits continue to account for the predominant share of gross financial
assets, with their share increasing sharply in the second half of 2000s in contrast to
the declining trend in the previous years; part of the recent increase in the share of
bank deposits could be attributable to the increase in deposits rale and aggressive
deposit mobilization by banks.
The share of life insurance funds continued to increase during 2000s, in line with
higher insurance penetration and robust economic growth. As indicated in the
Economic Survey 2010.

50
 Life insurance penetration in tlic year 2000 when tiie sector was opened up to
the private sector was 1.77 and it has increased to 4.73 in 2009. The increase in
levels of insurance penetration has to be assessed against the average growth of
over 8 percent in the GDP in the last five years.
The share of provident and pension funds has progressively declined over the years.
2.6 The Principle of Acceleration'^
The concept of 'Accelerator' refers to the number of times investment
expenditure increases in response to a change in consumption expenditure under given set
of conditions. In the process of economic growth, an increase in the level of income leads
to an increase in consumption expenditure by households. If an increase in consumption
expenditure is likely to continue in the long run, the capacity of existing capital equipment
falls short of the requirements, investment in capital goods must be increased to fulfill
additional demand for consumers' goods. The required investment for additional output is
much more than the change in the demand for consumers' goods.
J.M. Clark (1917) introduced the term Accelerator Principal further it was
developed by Hicks, Samuelson and Harrod.
Acceleration principal is based on the increase In the demand for capital goods as
a result of an increase in demand for consumer. Whenever the consumers' demand for
consumer goods increases, it will be followed by increase in investors demand for
capital goods. According to Kurihara, "The accelerator co-efficient is the ratio between
induced investment and initial changes in consumption expenditure":
Symbolically, p = Al/AC
Where p is accelerator coefficient,
AI is change in investment expenditure and
A C is change in consumption expenditure.
If the consumers' demand increases by Rs. 10 Crore, investors will have to
increase their investment in capital assets say, by Rs. 40 Crore, in this case the value of
accelerator is said to be 4.

2.6.1 Working of Accelerator'"

51
 If the capital output ratio is assumed to be 5:1. it implies that to produces goods
worth 10,000/- investment in capital goods required would be to the tune of Rs.
50,000/-or five times the change in initial change in consumer demand.
If AI is 10 Cr. and AC is 2 Cr. and accelerator it would mean that the value of
Accelerator is-

a = —= —= 5
AC 2

The acceleration principal is based on the following assumptions.""

1) Capital output ratio in the economy remains unchanged.
2) The resources available are ample; there is no scarcity of resources enabling
instant additional investment as and when needed.
3) The increase in demand for consumer goods is of payment nature, so that the
investors are assured of their investment being fruitful.
4) Supply of Credit is assumed to be elastic.
5) There is no time lag between rise in net investment and increase in
output. Following are the limitations of the principal of acceleration"':
1) We cannot expect a constant capital output ratio with the improvement in
technology this ratio is bound to change.
2) The availability of resources is also a very vague assumption there can be
shortage of resources available which can vary from time to time.
3) The plants and machinery always have uncured capacity or excess capacity
when there is an increase in demand there may not be additional investment on
capital goods.
4) The increase in demand for goods may not be of permanent nature.
5) If the producers will forecast an increase in demand for consumer goods indenture
and start preparation of that earlier the process of acceleration may not take
place 2,7 Multiplier:
2.7.1 Concept of Multiplier": -
F. A. Kahn in the year (1930) developed this theory. Latter on this was refined
by Keynes. F. A. Kahn developed this concept with reference to increase in direct and
indirect employment due to the initial increase in investment. Keynes developed this
concept with reference to increase in total income. So Kahn's multiplier is known as

52
employment multiplier and Keynes multiplier Is known as investment or income
multiplier.
The initial investment increase will increase the income, output and employment
many folds to that of increase in consumption expenditure, if this increases by two times
the multiplier is 2 and if it increases by 4 times than multiplier is 4.

The formula used for multiplier is K = — where K is multiplier A 1 is new

investment and A Y is new income.
The amount of multiplier will depend upon the MPC AMarginal Propensity to
Consumer) if the MPC is 80 % then the people will spend 80/- rupees out of 100/- Rs
of additional income and this way accusing 80 % as MPC this chain of income and
expenditure will continue up to the end and the income of profile will go an increasing.
2.7.2 Derivation of investment Multiplier^"^
This can be expressed in the mathematical form as

100 X- ^
1-415

=100x^
1/S

- 100x5
= 500
Thus when MPC is 4/5 the effect of multiplier effect is 5
times.\ The equation of multiplier is as follows
AY = Al ^
l-MPC

Here AY is increase in income Al is increase in investment and MPC is

marginal propensity to consume so
AY _ 1
M l-MPC
AY
— Measures the size of multiplier
A/ "^
SoK ^
l-MPC

We know the fact that Savings is the residual of income and consumption so the
multiplier is equal to

53
 1
l-MPC MPS

Diagrammatic representation of Multiplier

Figure 2.6 A

Panel - A
Y MPC = 0.5

,.
X C-I-AI

oj E' '/\_,„——-'*—' ' ____.——-c^i

01 _-—-^ c
'"E'/-
c>
T3 AI
C
TO
C
o 575/^
" Q.
E
3
c
p
O AY
X
o ^ r-^ t

Income

Figure 2.6 B
Panel B

MPS = 0.5

•>
(a
^ / ^
on
XJ
^ y ^
•£
Ty^ I-Al
E AI
<u
V]y^
I
>

AY
^---^
O Y Y X
Incon le

In the panel A the slope of the curve ' C is 0.5 which indicates that MPC is 50
% , C + I is the investment curve which intersects with the 45'"line at point E' showing
the income level at OY on X axis. The curve C+I moves upwards to C + I + AI hear is
54
government expenditure on the infrastructural development this curve now intersects
with the 45'^ line at E'" showing the new income as OY" therefore the change in income
from OY' to OY" is AY. It can be noticed that this distance is twice the distance
between C + 1 and C + 1 + Al. Since the MPC is 0.5, so the multiplier effect is 2.
The increase in income due to the multiplier effect has an impact on the savings
pattern of the households. This largely depends upon the amount of MPC. This can be
clear from the panel B in the above given figure. Over here, OS curve starting with a
negative note below the X axis and moving upwards with a positive note. We have the
first investment curve drawn parallel to X axis intersecting with OS curve at point E'
then autonomous investment takes place and this curve moves upwards as I + Al where
I is investment and Al is autonomous investment. The curve I +AI curve intersects with
the OS curve at point E". One can observe that the distance between Y' and Y" is twice
the distance between I and 1 + Al indicating twice the increase in income due to MPC
being 0.5.
2.7.3 Assumption of Multiplier^^
The theory of multiplier given by Keynes is based on certain assumptions which
are as follows.
i. The MPC is constant throughout.
ii. There is a change in autonomous investment only.
ill. Consumption is a function of current income.
iv. There is no time log in the entire multiplier process.
v. The factors of production are available for additional production, in other words
there is less than full employment situation prevailing in the economy.
2.7.4 Leakages of Multiplier^''
Following are the leakages.
1) The quantum of savings by the households will have an adverse effect on
the multiplier in of other words higher the MPS lesser will be the amount of
multiplier.
2) If the increased incomes are spent on the purchase of old stocks and
securities instead of consumer goods multiplier process will be hampered.
Same is true if the increased be income is used for clearing the old debts.

55
 3) If the induced investment will be followed by inflation the multiplier effect
will be multiplied.
4) If the increased income is used for import of goods then this is a leakage in
multiplier.
5) The progressive taxation policy in a country will weaken the multiplier effect.
6) If the producers are in position of finished goods then the increase in new
output will not take place.
2.7.5 Limitations of Multiplier^^
1) When there is a time log between income received and consumption it will have
a negative impact on the multiplier.
2) in an economy where there is a full employment situation prevailing multiplier
effect will not be noticed.
3) if the investment activity is once in a way the multiplier effect will not be up to
the mark.
4) In an open economy the chances of leakages are more so the amount of muhiplier
is small i.e. capital/money flow to outside countries in form of deposits.
5) The interaction between multiplier & accelerator generate fluctuations in
output, employment GDP, etc. which in turn also generate fluctuations in the
rate of savings by the households, MPC in the short run remaining Constant.
2.8 InHation
Inflation is always and everywhere a monetary phenomenon and can be
produced only by a more rapid increase in quantity of money then output.^''
2.8.1Meaning of Inflation
Inflation is an increase in the general price level. The prime cause of inflation is
excess supply of money.^^
There are major types of inflation are 1) Demand pull inflation 2) cost push
inflation 3) wage push inflation and 4) profit push inflation out of these are the major
course of inflation as well.

56
 2.8.2 Demand Pull InHation":
Whenever there is an increase in demand due to excess of money supply, this
may not be followed by an increase in the supply of goods beyond certain level the
prices are bound to rise. This can be made clear from the figure given below
Figure 2.7

ADS

AD2

Q3 Ql Q
Aggregates

In the figure given above we have two curves. AS curve which is Aggregate
supply curve and fair AD Curves which is Aggregate demand curves. In this figure we
show AD and as on the X axis and the price level on the y axis.
The as curve has a kink at point E2 this curve foam As to E2 is a normal supply
curve moving upwards from left to the right and from E2 to As it is a parallel line to 'Y'
axis in indicating supply cannot be increased Beyond point 0Q2. The first AD curve
intersects with AS curve at point 'E'. Then the increase in money supply due to C+l+G or
C+ 1+ G' takes place that is due to increase in the infrastructural development activities
taken up by the government the AD curve moves to the right to become AD, this intersect
with the As curve at El this intersects with the As curve at El this leads to increase in price
from OP to OPl and again AD, moves to AD2 to intersect at E2 to take the price to P2 in
both the situations a small amount of increase in supply is possible due to excess capacity
of the plant and machinery but when the AD curve is now as AD3 intersecting with the AS
curve at E3 there is a rise in price to 0P2 but this rise more than earlier price
57
rise as supply of goods cannot increase beyond 0P2 and excess supply of money will
force an increase in prices due to excess demand of goods which we call as demand
pull inflation.
Whenever there is a state of demand pull inflation then due to excess supply of
money there are also chances of excess savings by household-which can be attributed
as one more factor influencing savings.
2.8.3 Cost Push Innation^"
The basic cause of cost push inflation is increase in the input cost of production
like the prices of oil, raw material cost, electricity cost technology cost etc. This type of
inflation can be expressed with the help of figure given below.
Figure 2.8

Dl

Dl

ai Q F
QTY of Prod. tO.P.)

In the figure given above we have SS cure SSI, and SS2, curves as the supply
curves and DD and Di D i as the demand curves price levels shown on 'Y' axis and
quantity of production (OP) on y axis.
The demand curve DD intersects with the SS curve at point E this indicates that OQ
amount OP is sold at OP price. Then there is an increase in input cost which the producers
to culture supply of products, to the level of SSI. This curve intersects with the DD curve at
point El which indicates that there is a reduction in OP from OQ to OQ I to

58
the left side forcing the equilibrium position to move upwards to El, position to
increase to OP2. This also on the other hand will increase the unemployment. This kind
of inflation is termed as cost push inflation.
Whenever a cost push inflation situation arises there arc chances of increase in
unemployment and this will lead to disserving by the households. Domestic Savings,
Domestic Investment and Net foreign Investment^'
The savings of Government and the private sector together account for the total
savings in a country. (Economy) whenever there is a surplus budget due to less spending
then it receives taxes and when there is a deficit financing then there is dissaving.
Following is the equation for the level of savings in the economy. National
savings = Private savings + public savings or S = S private + S public.
S private or private savings is the amount of income not consumed by the
households i.e. = Y - C = S and the amount of tax paid by households so
Private Savings = National Income - Consumption - Taxes,
Or
Sp=Y-C-T
Public savings is equal to the difference between government spending and
taxes Government savings + taxes - Govt, spending.
Or
Public = T - G
Finally, the basic macroeconomic equation for GDP or National
income Y=C+1+G+NX
This equation can be used, our definitions of private and public savings, and the
fact that net exports equal to net foreign investment to arrives at the important
relationship known as Savings and investment equation.
National Savings = Domestic investment + Net foreign investment.
Or
This implies that economic savings will either be invested domesfically or
overseas which will largely depend upon the comparative rates of interest in the two
countries (Rate of returns)

<^j,e49e Re
59

^*>
 To sum up the entire discussion in tliis section, tlie principle of Accelerator,
concept of Multiplier and Inflation do have some impact on the level of income, saving
and investment behavior of households. Interaction of accelerator and multiplier
induces growth in income, saving and investment under the given set of conditions.
Inflation, on the other hand, erodes real income, discourages savings and investment.
In the present study, an attempt is made to trace the reasons behind changes in
the saving investment behavior of sample households in Nashik and around under
changing economic environment such as level of income, inflation, fluctuations in the
market prices of assets and so on.
2.9 Summary
Macroeconomic theory predicts a straight forward positive correlation between
income (Y), saving (S) and Investment; saving and investment amounts tend to rise when
income increases and fall with a fall in income. However, on micro level, when income of
an individual increases, his consumption increases but not exactly in proportion to rise in
his income but goes on declining as the income increases. Conversely, savings also
increase with a rise in money income but in relation to income added, rate of saving goes
on increasing with every rise in income, in Technical terms, a change in income leads to
less than proportionate change in consumption, which is called MFC; marginal propensity
to consume AC/AY goes on decreasing as income increases and vice-versa. Marginal
propensity to save is a change in saving in response to a change in income is defined as
AS/AY on the other hand shows a positive relationship with a change in income. MPS goes
on increasing with increasing income and falls as income falls. These theoretical
predictions will be tested on the basis of empirical data in chapters 5 and 6.

The coefficient C is termed as 'Marginal Propensity to consume' (MPC) i.e. with

the increase in Y, C also will increase. But in practice, at a later stage we will not find
the increase in Y equaling the increase in C.
Saving Function
Budget Constraints is putting the above two equations together i.e. Saving Function
equation, where c is autonomous consumption expenditure, even though the income is
zero, that much consumption expenditure is a must.
C=c+CY c>0 0<C<]

60
And Saving Function equation Y - C = S, we derive of a new equation
Y - C = S = Y - c - CY = - c + (I - C) Y
Saving is an increasing function of the levels of income MPC is i - C = S is
positive, in other words when the ratio between Y & C is 80: 20, When Y increase by
Rs. 100/- C only increase by Rs. 80/- and the balance Rs. 20/- is savings. Therefore one
important factor of savings is level of Y.
K and 1 are related to each by net investment, (jross investment is the total
amount spent on new K. on the other side some K wears out every year which is
depreciation. So net 1 is gross investment minus depreciation which is net addition to
the stock of K. to the economy. If gross 1 is equal to the depreciation then there is no
addition to the economies K stock. If gross investment is less than depreciation then it is
equal to disinvestment. So gross investment is more than the depreciation it will add to
the net investment.
When Y increases consumption demand increases will be followed by Autonomous
investment. So, 1 =f (Y) this investment is directly related to income and is income
elastic i.e. more the Y more will be the volume of I. The induced investment may be
further divided into two types -
Average Propensity to Invest (API)
Marginal Propensity to Invest (MPI)

Average Propensity to Interest (API) - This is the ratio of investment to Y i.e. I/Y. If Y
is 50 Crore and I is 5 Crore then I/Y will be 5/50 = 0.1
Marginal Propensity to Invest (MPI) - This is the ratio of change in I to change in Y i.e.
AI/AY. If I change by 2 Crore and Y changes by 10 Crore then AI/AY will be 2/10 = 0.2
Marginal Efficiency of Investment is the rate of return expected trom aa given I
on a K asset after covering all its costs, expect the Rl, lower the Rl higher will be the 1
and Vice versa.
The classist economists were of the opinion that S always equals I because both S
and I are the functions of Rl
S = f(r)
l = f(r)

61
Therefore, S = I
Theory believes that when the r increases, the savings will increase but at the
same time 1 will decrease and Vice Versa.
The classical economists were of the opinion that S always equals 1 because of
both S and 1 arc the functions of rate of interest: S=f (r) 2. l=f (r). Therefore S=l. They
believed when the rate of interest increases, the savings will increase but at the same
time I will decrease and vice versa. This is already cleared with the help of the figure
given earlier.
View of Keynes was criticized on the grounds that the people who S and 1 take
their decisions independently considering number of factors like investors will decide to
I considering rate of interest and people who some will take their decisions
considering Y level future requirements, price levels etc. Therefore, saving can never
equal Investment.
Other factors responsible to decide the rate of S: - a) Level of Y b) rate of interest,
size of family. Larger is the size of family, lesser will be the amount of S d) Interval of Y
earnings: - Smaller the intervals between earnings Y\ smaller will be the per cent of savings
of the families. Bigger the intervals larger will be the per cent of S. e) Level of Inflation in
the economy, higher the per cent of inflation and longer the period it continues in the
economy smaller will be the per cent of savings, f) Speculations in the H.H speculate a
drop in price in future they will save today to be spent at latter day. g)
Health conditions in the family if the in the houses is very stable then the quantum of
the savings would be more, h) Various agents: If various agents will appoint agents like
postal agents, LIG agents, M.F agents, daily collection agents, etc. they will encourage
in good amount of savings even for small amounts, i) Price of precious metals: If the
prices of gold, silver, platinum, diamond is high the rate of savings will be high)
Composition of the family:- If the parents have more female members than the male
members then the rate of savings will be more so that the couple can take care of
themselves with out-taking help of any one.
There is no specific methodology used to find out the amount of savings by
households accurately as lot of time and money will be involved in understanding that.

62
So the latest flow of fund data may be used i.e. up to 2000-01 which exhibits an
average of 93 per cent for house hold cash holdings.
To sum up macroeconomic predictions, as the aggregate level of income
increases, aggregate consumption expenditure goes on falling, resulting in increase in
savings and the various avenues of savings are increasingly put to use in terms of
capital formation for generating more income in future. Let us test this relationship on
the basis of empirical study in the chapters that follow.

63
References -

1. H. L. Ahuja, Macroeconomics: Theory and Policy, S. Chand Publication,

Seventeenth Edition, 2011, p. 145
2. Ibid, p. 149
3. Ibid, p. 129-130
4. Ibid, p. 90
5. Ibid, p. 150
6. ibid, p. 148
7. Ibid, p. 183
8. ibid, p. 175
9. Ibid, p. 176
10.M. L. Jhingan, Macro Economic Theory, Vrinda Publication, 11* Edition, p. \
43-148
11.Ibid, p. 143-148
12.Ibid, p. 148-151
13.Ibid, p. 143-148
14.Ibid, p. 143-148
15.Data book for Planning Commission, p. 29
16.RBI Bulletin, April 2009, p. 106-116
17. Report of the Working Group on Savings during the Twelfth Five-Year Plan
(2012-13 to 2016-17), p. 1167-1170
18.Jhingan, op. cit., p. 177
19. Burange, L. G. and Chapalgaonkar S. M.. Business Economics (Macro),
NarendraPrakashan, p. 212
20. Jhingan, op. cit., p. 181
21. Ibid, p. 181-182
22. Ahuja, op. cit., p. 171
23. Ibid, p. 172
24. Jhingan, op. cit., p. 156-157
25. Ibid, p. 157-158

64
26. Ne. Thi. Somashekhar, Modern Macro Economic Theory, Anmol Publication,
2005, p. 58
27. Jhingan, op. cit., p. 406
28. Ahuja, op. cit., p. 406
29. Ibid, p. 407
30. Burange and Chapalgaonkar, op. cit., p. 97-99
31. R. Glenn Hubbard and Antiiony Patrick O' Brian, Macro Economics, Dorling
Kindersley (India) Pvt. Ltd., 2007, p.

65