CONSUMPTION, SAVINGS, INVESTMENT FUNCTION WWW.ANUJJINDAL.IN WHY OUR COURSE! 1) Save Videos offline 2) Downloadable & printable PDFs 3) Sectional Tests & Comprehensive Mocks with All India Ranking System 4) We Check Your English Papers. English is the most scoring in Phase 2.Table of Contents Consumption function. Autonomous consumption ‘Marginal propensity to consume. Savings function es Determinants of Consumption and Saving: INVESTMENT FUNCTION Induced investment Autonomous investment Determinants of investment Marginal efficiency of investment ... Rate of interest. Aggregate demans In two sector model, Aggregate Supply: ‘Aggregate supply refers to the money value of final goods and services that all the producers are willing to supply in an economy in a given time period. ‘Ageregate supply = National Income. When AS is expressed in Physical terms, it refers to total output of goods and services in an economy... ‘Thus, AS and National Income (Y) are the same thing. National Income = Consumption (C) + Savings (S) Savings and investment approach... eseenessese Introducing the government sector and the foreign sector into the analysi EMIT AYConsumption function — Even with 0 disposable income, households still consume through recorded savings. For every additional income, they spend / consume a part of it and save the remaining. The consumption expenditure of an economy depends upon a large number of factors such as household disposable income, taxation, inflation, tastes and preferences, current prices, expected prices ete Inshort run, consumption expenditure is mainly determined hy disposable income. | Consumption (C) is a function of disposable income (YD). sumption function nomous consumption sity to consume (MPC) Important terms: Autonomous consumption: It does not vary with the level of income. It represents the Y- axis intercept, showing the level of consumption when income is zero. Marginal propensity to consume: marginal propensity to consume (MPC) is defined as the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. Consumption Expendit intercept= = autonomous consumptionLet us say that C = 40 + 0.80 (Disposable income) The constant 40 is referred to as autonomous consumption because It does not change as DI changes. The slope of consumption function is 0.80. CONSUMPTION, S ahiLe ts Savings function Savings refer to that part of national income that is not consumed or spent on purchase of goods and services. The savings function relates the level of savings to the level of income, S=t+(I-b)Y Saving Function Curve “a SeE+(1-b)Y Saving (s) ia x || Disposable income (¥) ‘Break-even point no RHEIMPORTANT POINTS 1. When income is zero, total spending is positive, causing dis-savings. 2. Asincome rises, total savings rise. 3. The slope of the saving function is given by the marginal propensity to save which is equal to (1-b).. Diaporabie income Fig. 8.7 Determinants of Consumption and Saving: MF 1ien) Sfel-Toie- 4 tesa 7 transfers 1 Wealth- When value of accumulated wealth increases, consumption rises, and savings function shifts downward because consumers can sell stock and consume more Macae| WANT TOPREPAREFOR I, SEBIG NABARD EXAMS eae i 2. Expectations Uncertai savings. An expectation of a higher future price goes vice versa. 3. Household Debt- households can increase consumption with more debt. But as debt increases, more disposable income is to be used to pay off debt, reducing consumption. 4, Taxes and transfers- taxes impact consumption and saving in the same direction. Situation 1- taxes rise- both consumption and savings decrease. Situation 2- transfers rise- both consumption and savings go up. isis TAU NPNINVESTMENT FUNCTION Investment refers to the expenditure incurred on creation of new capital assets. Induced Investment — Induced investment refers to the investment which depends on the profit expectations and is directly influenced by income level. Autonomous investment — Autonomous investment refers to the investment which is not affected by changes in the level of income and is not induced solely by profit motive. Determinants of investment According to Keynes, the decision to invest in a new project (i.e., private investment) depends upon two factors: 1, Marginal efficiency of investment 2. Rate of interest Marginal efficiency of investment: MEI refers to the expected rate of return from an additional investment. MEI is determined by two factors: © Supply price: it is the price at which the new capital asset can be supplied or replaced. ‘* Positive yield: it refers to net return, expected from the capital asset over its life time, Rate of interest: it refers to cost of borrowing money for financing the investment. Aggregate demand — It refers to the total demand for all goods and services by the people in the economy during a given period of time. AGGREGATE DE) CONSUMPTION (C) + INVESTMENT DEMAND (1) + GOVERNMENT DEMAND (G) + NET EXPORT DEMAND (NX) In two sector modi An economy is in equilibrium when the quantity of ouput produced (¥) is equal to the quantity of output demanded (aggregate demand AD)There is\inplanned inventory investment (CSS ela accumulation) WSS Ty Ent Inventory dis= investment (past: TTS Tp JEL) out), DINDRIAI EeAggregate Supply: Aggregate supply refers to the money value of final goods and services that all the producers are willing to supply in an economy in a given time period. Aggregate supply = National Income When AS is expressed In Physical terms, it refers to total output of goods and services in an economy. Thus, AS and National Income (Y) are the same thing. National Income = Consumption (C) + Savings (5 < § 8 8 3 i é 3 & 3 3 Woo 700 300 400-600 National income (& crore) (Aggregate Supply) Fig. 8.2‘Savings and investment approach Equilibrium in a two sector economy is established where planned investment (ex-ante investments) equals savings At OYi* level of income, Consumption (C) = MY." Income = E:* Yi" Savings = Income - Consumption = E:*M Also, E:*M is equal to T. ‘Therefore, equilibrium is established at OY1* level of income where S = 1 At OYz level of income, Consumption (C) = HY2 Y2 income — Consumption = PH GH Hence, at OY: level of income equilibrium is not established. Conclusion: Equilibrium is established where savings are equal to planned investments.‘Under four sector model, in equilibrium, planned investment fs equal to the sum of private savings plus government budget surplus plus net imports. Introducing the government sector and the foreign sector into the analysis Each component of government spending, taxes, net exports are assumed to be given and remain unchanged (i.e., they are considered autonomous) Government spending = G Taxes = TA Transfers = TR Net exports = NX Consumption will be a function of disposable income Disposable income = [(gross) income ~ Taxes + Transfers] C=c+b(Y-TA+TR) With all he four sectors being considered the aggregate demand shall be, AD =t+b(Y¥-TA+TR)+1+G+NX Letc+T+G+N IX=A AD=A+bY * AD increases with the increase in ¥ (National income or Aggregate Supply), because consumption demand increases with income.i aE z The AD curve in a four sector model is obtained by vertically summating the demand for consumption, investment, government spending and net exports at each level of income. Important observations: ‘The position of AD curve is determined by A and b. Given A, a high MPC (b) implies a higher equilibrium level of income. Given b, a high A implies higher equilibrium level of income. We can compute the change in output (AY) when changes in autonomous spending (QA) take place using the formula: 1 ay=7— OACota INU eT ACen Tet RUT RANLUTNM IVAN EaesoesS te Ly [TDDUISp