Explain the relationship between consumption and savings

explain the relationship between consumption and savings

The line C is the consumption function. It shows the relation between planned consumption expenditure and national income. In a like manner the saving. Explain the relationship between consumption and saving. The relationship between consumption and saving relies heavily on one's disposable income. Consumption and Saving. The consumption function is a relationship between current disposable income and current consumption. It is intended as a .

explain the relationship between consumption and savings

There is a level of debt beyond which consumers feel uncomfortable with additional spending. Even if income has stayed the same, if too much debt accumulates, consumers will start to spend less and pay off debt. This is illustrated by a downward shift in the Consumption Function and an upward shift in the Savings Function remember that paying off debt is the same thing as increasing savings.

The opposite is also true.

The Relationship Between Income & Expenditure

At low levels of debt people will consume more and save less. You can likely think of other factors that are unrelated to income that could shift the Consumption and Savings Functions. In general, anything that influences consumption or savings that is NOT disposable income will shift the Functions upward or downward.

Any change in disposable income will move you along the Functions.

Economics in a Moment: Consumption and Savings Function

Return to the course in I-Learn and complete the activity that corresponds with this material. The Interest Rate — Investment Relationship The second component of aggregate expenditures that plays a significant role in our economy is Investment. Remember from our lesson on National Income Accounting that investment only occurs when real capital is created. Investment is such an important part of our economy because it affects both short-run aggregate demand and long-run economic growth.

The dollars spent on the investment have the immediate impact of increasing spending in the current time period. But because of the nature of investment, it has a long-term impact on the economy as well. If a company buys a new machine, that machine is going to operate, continue to produce, and will have an impact on the productive capacity of the economy for years to come.

This is in contrast to consumption purchases that do not have the same impact. If you buy and eat an apple today, that apple does not continue to provide consumption benefits into the future. Before the investment takes place, firms only know their expected rate of return. Therefore, investment almost always involves some risk. Consider the following scenario.

explain the relationship between consumption and savings

You know that your equipment is slow and outdated. You also know that investing in modern computerized printing presses will yield a positive return for your business, but that they will be very expensive.

ECON Macroeconomics

In order to undertake the investment in new equipment, you will have to borrow the money. Should you borrow the money and buy the new equipment? What will influence you decision? The key variable that will help you to decide whether the investment makes sense for you is the real interest rate that you will have to pay on the loan.

If the expected rate of return in greater than the real interest rate, the investment makes sense. If it is not, then the investment will not be profitable. The real interest rate determines the level of investment, even if you do not have to borrow the money to buy the equipment. The Investment Demand Curve As was illustrated in the example above, the real rate of interest has an impact on determining which investments can be undertaken profitably and which cannot.

Graphical Representation of Consumption and Saving

Meaning money is spent on expenditures, at times, even if there isn't enough income to cover them. This is a common economic principal used to describe spending trends for national and world economies.

A business should consider the relationship between consumption and savings to extract data on buyer trends within its own industry. Expenditure and Income The difference between income and consumption is used to define the consumption schedule.

Graphical Representation of Consumption and Saving

When income grows, disposable income rises and thus consumers buy more goods. The result is an increase in the consumption of major purchases and non-essential goods.

The increase in consumer expenditures is not a direct relationship to income. For every extra dollar earned, there may be a fraction spent on disposable income.

explain the relationship between consumption and savings

Low-income areas may actually see more in expenditures than in actual income at different times. The difference between income and consumption is how much is spent and left over as savings at the end of the month.

There are many factors that determine why consumers choose to spend more on goods not required for day-to-day living expenses. These include stock market trends, tax laws, and even consumer optimism. Economic experts look at historical data to predict future trends based on new market conditions. The Effect of Consumer Confidence Consumers won't spend money unless they are confident in their personal economic situation and strength.

This means consumers feel good about having and keeping a job with the potential of promotion. Pay increases, stock portfolio rises and tax cuts can put more money in each person's pocket. As these conditions merge, consumer confidence increases.