BANEZ, CATHRINE MAE

CONSUMPTION
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AND SAVINGS
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BASIC
CONCEPTS OF
CONSUMPTION CONSUMPTION
• - what household, not business
do
• - value of goods and services
bought by people
• - the use of goods and services
by households.
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COMPONENTS: Personal consumption expenditures
consist of household purchases of
durable goods, nondurable goods, and
services.

Personal consumption expenditures

are the largest component of GDP.

Personal consumption expenditures

are a relatively stable component of
GDP
 “Keynesian Consumption Function”
z
- introduced by British economist John
Maynard Keynes
- the function could be used to track and
predict total aggregate consumption
expenditures.
CONSUMPTION
FUNCTION C = A + MY
where :
A = autonomous consumption
M = marginal propensity to consume
Y = income
z
1. Calculate consumption level for Y =
Php1,000 if consumption function is C
= 300 + 0.5Y

EXAMPLE: Solution:
C = 300 + 0.5Y
= 300 + 0.5(1,000)
= Php 800
z 2. Find out income level when
consumption =Php 1200 and
consumption function is C = 100 +
0.5Y
Solution:
EXAMPLE
 1200 = 100 + 0.5Y
 1,200 – 100 = 0.5Y
 1,100 = 0.5Y
1,100
 = Php 2,200
0.5
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CONSUMPTION AND INCOME
1. According to Keynes, as income increases, consumption
expenditure also increases but by less than the increase in
income. In other words, when income increases,
consumption expenditure does not increase at the same
rate as income. This is called Keynesian Psychological
law of consumption.
a) INDUCED CONSUMPTION

b) AUTONOMOUS CONSUMPTION

2. When income is very low, consumption expenditure is

higher than income.
BANEZ, NICOLE P.

MULTIPLIER
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CONCEPTS
Multiplier is the process of generating
income trough the circular flow exchange
betweenz the household and the firms.

Multiplier Effect denotes the phenomenon

whereby some initial or decrease in the rate
of spending will bring about a more than
proportionate increase of decrease in
national income
z
Theory and equations were created by WHAT DOES IT
British economist John Maynard Keynes MEAN?

2 Important Features
a. cumulative process rather instantaneous
effect
b. value of multiplier depends on the
fraction of extra income that is spent on
consumption (MPC)
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CONSUMPTION FACTOR OF THE
MULTIPLIER

1 2
THE MARGINAL MARGINAL PROPENSITY
PROPENSITY TO TO SAVE (mps)
CONSUME (mpc) The size of the multiplier
The size of the multiplier depends upon household’s
depends upon household’s marginal decisions to save
marginal decisions to spend
z
MULTIPLIER COEFFICIENT

𝟏 𝟏
K = =
𝟏 −𝑴𝑷𝑪 𝑴𝑷𝑺
Where:
K = multiplier coefficient
MPC = marginal propensity to consume
MPS = 1 – MPC = marginal propensity to save
z

 Customer spend 0.8 and save 0.2 of

evert P1 of extra income, the multiplier
will be:
1
EXAMPLE: =
1 −𝑀𝑃𝐶
1
=
1 −0.8
1
= =5 hence, the multiplier is 5,
0.2
which means that every P1 of new income
generates P5 of extra income
CONSUMPTION
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AND SAVINGS
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CONSUMPTION CONSUMPTION
VS SAVINGS
• Value of goods and services bought
by people
• Largest part of total spending

SAVINGS

• according to Keynesian economics,

consists of the amount left over
when the cost of a person's
consumer expenditure is subtracted
from the amount of disposable
income he earns in a given period of
time.
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RELATIONSHIP INCOME = CONSUMPTION
BETWEEN + SAVINGS
CONSUMPTION
AND SAVINGS C = f (Y)

• If income increases, consumption also

increases, but not quickly as income

S = F (Y)

• If income increases, savings also

increases, but at the higher rate than
income
FACTORS OF
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CONSUMPTION
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1 2 3 4
INCOME LEVEL TASTE AND POPULATION PRICE LEVEL
PREFERENCES
• Additional income • Decrease in • Consumer seek the
yields additional • Change in household size with best mix in the
consumption. collective attitude income and other consumption of
can change factors increasing available products
aggregate taste may reduce through
and preferences household’s substitution.
propensity to
consume and
increase its saving
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5 6 7 8
PSYCHOLOGICAL INNOVATION AND THE RATE OF STRUCTURAL
FACTORS PROMOTION INTEREST FACTORS
• enjoyment, short- • Can expand the line of • increase in interest • Structural factors like
sightedness, customer’s choice and rate encourages income distribution,
generosity, extend the influence of saving and, thus, demographic factors,
miscalculation, demand factors consumption is etc., do have some
extravagance, and discouraged bearing on the
ostentation
aggregate
consumption spending
in the long run
Investment Function
Investment: A Determinant of Income
• Investment Expenditure – capital spending mainly
derived not from current income and consumption
but from accumulated savings and other sources
external to the circular flow

• Investment – capital expenditure on the purchase of

physical assets such as plant, machinery and
equipment (fixed investment) and stock (inventory
investments)
Investment: A Determinant of Income
• Why is investment essential to the economy?
– Current business income serves current business
needs and the surplus may not suffice to finance
even a fraction of investment spending thus a
business borrow the savings of the economy.
– Investment therefore requires that an amount of
current consumption to be forgone (saved) so as
to release the resources to finance investment.
Investment: A Determinant of Income
• Investment Expenditure – a component of aggregate
demand and an injection to the circular flow of
national income because investment increases
capital stock and the expenditures for which it
generates income as inflows to the circular flow
– consists only of private sector investment
spending
Importance of Investment Function in an Economy
• The level of income, output and employment in an
economy depends upon effective demand, which in turn,
depends upon expenditures on consumption goods and
investment goods.
• Out of the two components (consumption and
investment) of income, consumption being stable,
fluctuations in effective demand (income) are to be
traced through fluctuations in investment.
• Investment, thus, comes to play a strategic role in
determining the level of income, output and
employment at a time.
Investment: A Determinant of Income
• Investment Spending – not the monopoly of
business but is extended to households and the
government as well

• Households – spend on fixed assets which are yet to

be consumed gradually over a long period of time
(ex. TV)
• Government – spends on social overhead facilities to
provide stream of social benefits during a long period
of time (ex. Good road facilities)
Investment: A Determinant of Income
Consumption vs Investment Expenditures

• Consumption Expenditures – spending on current

consumption/ consumption of nondurable goods
• Investment Expenditures – spending on capital
goods which are repeatedly used and gradually
consumed over a long period of time as in durable
goods
– prepayment of long-term consumption
Investment: A Determinant of Income
• Investment – can be divided into:

1. Gross Investment – total amount of investment that

is undertaken by an economy over a specified
period (usually one year)
2. Net Investment – gross investment less
replacement investment of capital consumption
Investment and the Multiplier
• How does investment spending determine income?
Investment and Output
• Generally, business and household investments
increase economy’s stock of capital and total output
whereas depreciation has the opposite effect as it
represents capital consumption
• While current depreciation decreases total output in
the short run, current investment yields output in the
long run for two reasons.
Investment and Output
• First, even after total investment expenditure to
meet production targets has already been incurred,
the process of setting up and even testing the capital
base creates operational lags
• Second, every phase in setting up a capital base may
not be capable of independent utilization until the
completion of the other phases
Investment and the Stock Adjustment Process
• Despite the investment-production time lag,
sustained investment expansion can determine
growth in the capital stock and production level of a
firm or the aggregate economy over a long period of
time
• Capital Stock – net accumulation of a physical stock
of capital goods (gross investment less depreciation)
such as buildings, plant, machinery, etc.
Investment and the Stock Adjustment Process
• Investment increases capital stock since new capital
brings additional production capacity.
• Investment increases capital stock while depreciation
decreases the current capital stock.
• They are directly associated with output.
Investment and the Stock Adjustment Process
KRIZIA GAIL ILANO

SAVING AS A
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FORM OF
INVESTMENT
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z SAVINGS
DEFINITIONS
• savings is whatever is left over after income is spent on
consumption of goods and services

INVESTMENT

• investment is what is spent on goods and services that

are not 'consumed', but are durable

SAVINGS VS. INVESTMENT

• The motive for saving is one of deferring your

consumption to a later day. We save when we
consume only part of our income now and save for
retirement, a rainy day, putting children through college,
the summer home, etc.
• supply of funds for investment
• The motive for investment is to make money.
Investment takes place when we purchase plants or
equipment, which make workers and businesses more
productive in the future.
• demand for funds
 z
 Keynes defined saving and investment in such a
way that in his theory, SAVING ALWAYS
EQUALS INVESTMENT.

 This is called accounting equality.

ACCOUNTING  O = C + I where O=output, C=consumption

EQUALITY and I=investment
 Y = C + S where Y=government income,
C=consumption and S=savings
 O=Y

 C+I=C+S

 I=S
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DETERMINANTS INTEREST RATES
OF • higher interest rates tend to reduce the quantity of
INVESTMENT investment, while lower interest rates increase it

EXPECTATIONS

• As expectations change in a way that increases

the expected return from investment, the
investment demand curve shifts to the right.
Similarly, expectations of reduced profitability shift
the investment demand curve to the left

THE LEVEL OF ECONOMIC

ACTIVITY
• Firms need capital to produce goods and
services. An increase in the level of production is
likely to boost demand for capital and thus lead to
greater investment
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z THE STOCK OF CAPITAL
DETERMINANTS
OF
INVESTMENT CAPACITY UTILIZATION

• If a large percentage of the current capital stock is

being utilized, firms are more likely to increase
investment than they would if a large percentage
of the capital stock were sitting idle.

THE COST OF CAPITAL GOODS

• If the cost of capital goods rises, then the quantity

of investment at any interest rate is likely to fall.

TECHNOLOGICAL CHANGE

PUBLIC POLICY
RAVEN, CABRAL

THE IMPACTS OF
z

GOVERNMENT
BORROWING
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z
LEARNING
OBJECTIVES Explain the national saving* and
1. investment identity** in terms of
demand and supply
*In economics, a country's national savings is the
sum of private and public savings. It is generally
equal to a nation's income minus consumption and
government purchases.

**The savings identity or the savings-investment

identity is a concept in national income accounting
stating that the amount saved in an economy will be
the amount invested in new physical machinery, new
inventories, and alike. Evaluate the role of budget
***A budget surplus is a period when income or surplus*** and trade surplus****
receipts exceed outlays or expenditures. A budget 2. in national saving and investment
surplus often refers to the financial states of
governments; individuals prefer to use the term
'savings' instead of the term 'budget surplus.'
identity
Asurplus is an indication that the government is
being effectively managed.

****Country’s exports exceeds the costs of its

imports
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z
GOVERNMENTS AS POSSIBLE SOURCES:
BORROWERS IN
FINANCIAL • households might save
MARKETS:
more
• private firms might borrow
less
• the additional funds for
government borrowing
might come from outside
the country, from foreign
financial investors.
 z
z
NATIONAL shows the relationships between
SAVING AND the sources of demand and
INVESTEMNT supply in financial capital
markets*.
IDENTITY

The identity begins with a

statement that must always hold
true: the quantity of financial
A financial market brings buyers and sellers
together to trade in financial assets such as
capital supplied in the market
stocks, bonds, commodities, derivatives and
currencies. The purpose of a financial must equal the quantity of
market is to set prices for global trade,
raise capital, and transfer liquidity and risk. financial capital demanded.
 z TOTAL SAVINGS = PUBLIC
z
NATIONAL SAVINGS (T-G) + PRIVATE
SAVINGS
SAVING AND
INVESTMENT
IDENTITY Y = national income (GDP)
C = consumption
I = investment and government purchases
T = taxes paid by consumers that goes directly to the
government
TR = transfers paid by the government to the consumers
G = Government purchases
Note: Transfer is different from subsidies.

Transfer payments are money that government (T-G-TR) + (Y-T+TR-C)

gives out without any work done not directly but in
the form of tax free and not accounted for in GDP
calculation. (ex. Educ assistance)

Subsidies refer to as a mechanism that government

use in keeping price stable by giving out money or
reducing taxes to facilitate production by firms or
industries. (ex. Programs for farmers)
 z
z
NATIONAL Include inflow of foreign financial capital
from abroad
SAVINGS AND
INVESTMENT This inflow of foreign investment capital can
be written as imports (M) minus exports (X)

Two main sources of demand for financial

capital
• Private Sector
• Government Borrowing
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QUANTITY SUPPLIED OF
GOVERNMENT FINANCIAL CAPITAL = QUANTITY
BORROWING IS DEMANDED OF FINANCIAL
CAPITAL
EQUAL TO THE
BUDGET DEFICIT PRIVATE SAVINGS + INFLOW OF
Govt spending > FOREIGN SAVINGS = PRIVATE
Taxes paid to the INVESTEMENT + GOVERNMENT
govt BUDGET DEFICIT (G – T)
 z

z Figure 1. Effects of Change in Budget Surplus or Deficit on Investment, Savings, and The Trade Balance Chart. (a) shows
the potential results when the budget deficit rises (or budget surplus falls). Chart (b) shows the potential results when the
budget deficit falls (or budget surplus rises).
 Example

 Supposezthat GDP is 10,000, Tax is 1,500, Government spending is 4,000 and consumption is 4,000.
Calculate Public Savings, Private savings and National Savings.

 Using the public savings equation

 Public Savings = T – G

Public Savings = 1,500 - 4,000

Public Savings = -2500
This suggests that the government is running a budget deficit.

 Using the Private savings equation

Private savings = Y - T – C
Private savings = 10,000 - 1,500 - 4,000
Private savings = 4,500

 Now using the National savings equation

National Savings = Public Savings + Private Savings

National Savings = -2500 + 4,500
National Savings = 2,000
z

WHAT ABOUT BUDGET

z SURPLUS AND TRADE
SURPLUS?
 z
z
NATIONAL QUANTITY SUPPLIED OF
SAVING AND FINANCIAL CAPITAL =
INVESTMENT QUANTITY DEMANDED OF
IDENTITY FINANCIAL CAPITAL
Budget Surplus PRIVATE SAVINGS + TRADE
Trade deficit DEFICIT + GOVERNMENT
SURPLUS = PRIVATE
INVESTMENT
(always consider the equilibrium)
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NATIONAL QUANTITY SUPPLIED OF
FINANCIAL CAPITAL = QUANTITY
SAVING AND DEMANDED OF FINANCIAL
INVESTMENT CAPITAL
IDENTITY
PRIVATE SAVINGS = PRIVATE
Budget Deficit INVESTEMENT + OUTFLOW OF
FOREIGN SAVINGS +
Trade Surplus GOVERNMENT BUDGET DEFICIT
 z
z TOTAL SAVINGS =
Summary of PUBLIC SAVINGS + PRIVATE SAVINGS
FORMULA:
Whereas:
PRIVATE SAVINGS = TRADE SURPLUS + BUDGET
DEFICIT + PRIVATE INVESTMENT

PUBLIC SAVINGS = TAXES – GOVERNMENT SPENDING

AND CONSUMPTION
 z
 A change in any part of the
national saving and investment
KEY identity suggests that if the
CONCEPTS government budget deficit
AND changes, then either private
SUMMARY savings, private investment in
physical capital, or the trade
balance—or some combination of
the three—must change as well.
INVESTMENT
z
BUSINESS
CYCLES
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z
INVESTMENTS
one of dozens of potential
causes of business-cycle
instability and the onset of a
business-cycle contraction

WHY? Because the business

sector, in the normal pursuit
of profit, creates surpluses
and shortages of capital goods
as it reacts to interest
rates, market conditions, and
expectations of the future state
of the economy
 z

 generates higher interest rates and

a surplus of capital that prompts a
decrease in investment and a
business-cycle contraction. A
BUSINESS-
CYCLE contraction then generates lower
EXPANSION interest rates and a shortage of
capital that prompts an increase in
investment and a business-cycle
expansion.
 z
z How is it that investment--which is only about 15
Working to 20 percent of GDP and usually the smallest of
Through the the three domestic expenditures--can possibly
cause instability in the aggregate economy?
Circular Flow

A decrease in investment means a reduction in

the production of capital goods, which means
fewer factor payments to the resources that
produce capital goods. With less income, these
resources buy fewer consumption goods, which
reduces the revenue of other producers
 z
z
FOUR
PROPOSITIONS
Investment expenditures are sensitive to
interest rates

Interest rates tend to rise during an

expansion and fall during a contraction

Competitive forces induce businesses to

create capital surpluses and shortages

Investment expenditures are lumpy

 z
z
First, interest rates are relatively low near the end of a contraction
THE
INVESTMENT Second, these conditions prompt a big increase in capital investment
expenditures by the business sector
BUSINESS
CYCLE IN Third, this cumulatively reinforcing increase in production, income, and
consumption is seen as the onset of a business-cycle expansion
ACTION
Fourth, the seeds of a contraction are planted during the expansion.

Fifth, these conditions eventually prompt a decrease in capital

investment expenditures by the business sector.

Sixth, this cumulatively reinforcing decrease in production, income, and

consumption is seen as the onset of a business-cycle contraction.

Seventh, during the contraction interest rates decline. Existing capital is

depreciated and needs replacing.
 This explanation implies that investment-induced
z
instability is a natural consequence of a market-based
economy. In the pursuit of profit, businesses make
individual decisions that collectively trigger business-
cycle expansions and contractions and the associated
problems of inflation and unemployment.

WHAT IT  An expanding economy, caused by greater

MEANS? investment, induces higher interest rates that
eventually discourages investment and triggers a
contraction.

 A contracting economy, however, causes lower

interest rates that eventually entices greater
investment that prompts the onset of another
expansion.