CONSUMPTION ,SAVING

AND INVESTMENT

Group Members
Submit By:
Syed Faraz Hussain
Danial Mudassir
Farhan Pervez
Zaid Nisar Memon
M.Hammad Farrukh Ansari
Submit To:
Mr. Asif Qureshi

5236
6025
5366
7514
5678

Topics To Be Covered
Income,

Consumption and Saving.

The

Consumption and Saving Function.

The

Marginal Propensity to Consume and Save.

The

National Consumption Behavior.

Investment.

Consumption and Investment

Aggregate demand is the sum total of two

types of demand.

(a)

Consumption demand.

(b) Investment demand.

(Ref:K.K.Dewett)

Assumptions
(1)

(2)

This means that we assume that only income

changes, whereas the other variable like
income distribution, price movements,
growth of population etc remains more or
less constant.
The condition remain normal for instance
there is no hyperinflation or there is no war or
other abnormal condition.
(Ref:K.K.Dewett)

Definitions of Consumption
Consumption

is expenditures by households
on final goods and services.
(Ref:Samuelson Nordhaus)

Consumption

means the amount spent on

consumption at a given level of income.
(Ref:K.K.Dewett)

Elements of Consumption
Consumption

is the largest single components

of GDP, constitute 66% of total spending of the
last decade.
Consumption demand plays a very important
role for employment and income.
E.g. The Great Depression.
Fiscal policy plays a very important role for
consumption.
E.g. tax.
(Ref:K.K.Dewett)

Elements of Consumption
Major

elements of consumption are divided

into 3 categories: Durable, Non-durable and
Services.

Among

the most important categories are

housing, motor vehicle, food and medical care.

(Ref:Samuelson Nordhaus)

Consumption Patterns
Category of
Value
% of total
Consumption goods
Durable Goods
872
11.9%
(motor vehicles & parts, furniture & household
equipments etc.)
Non-durable
2,115
29.0%
(food, clothing & shoes, energy goods etc.)
Services
4,317
59.1%
(housing, household operations, transportation, medical
care, recreation etc.)
Total personal consumption expenditure
7,304

(Ref:Samuelson Nordhaus)
100%

Definitions of Saving
Saving

is the part of personal disposable

income that is not consumed.
(Ref:Samuelson Nordhaus)

The

difference of disposable income and

consumption.
Disposable income=consumption + saving
(Ref:K.K.Dewett)

SAVING
Saving

= Disposable income Consumption

ITEMS
AMOUNT
Personal Income
8929
(less; personal taxes)
(1,114)
Equals: Disposable P. Income
7,815
(less: personal outlays; consumption & interest)
(7,525)
Equals: personal saving
290
Saving as % of disposal income 3.7%
(Ref:Samuelson Nordhaus)

Factors influencing Consumption

Following

factors given below:

(1)The real income of the individual

(2) His past savings
(3) Rate of interest
(Ref:K.K.Dewett)

D.I=CONSUMPTION+SAVING
Disposable
Consumption
Income(1)
expenditure(2)
(3)
A.24,000
B.25000
C.26,000
D.27,000
E.28,000
F.29,000
G.30,000

24,200
25000
25,800
26,600
27,400
28,200
29,000
(Ref:Samuelson Nordhaus)

Net Saving

-200
0
200
400
600
800
1000

The consumption function

The

consumption function shows the

relationship between the level of
consumption expenditures and the level of
disposable personal income.
(Samuelson Nordhaus)

Propensity

to consume is called
consumption function. Consumption function
and propensity to consume means the whole
of the schedule showing consumption
expenditure at various levels of income.
(K K David)

The consumption function

Relationship between consumption and
income is measured by average and
marginal propensity to consume.
Thus average propensity to consume , APC=
c/y
where C stands for consumption and Y for
income
, MPC= change in c | change in y
C incremental change in consumption
Y incremental change in income

The consumption function

The

Consumption function relates the total

desired consumption spending on the
personal sector to the factor that determines
it. It is one of the central relationships in all
macroeconomics. The underlying behavior of
consumers depends on the income that they
actually have to spend their disposable
income.
(Lipsey &Chrystal)

Graphical representation
of
Consumption
Function
This concept is introduced by Keynes is based
on hypothesis that there is stable empirical
relationship between consumption and
income.
45 degree line has special property
The Break Even point shows no borrowing
no savings
At any point on the 45 degree line,
consumption exactly equals income and
household has zero saving.

Graphical representation of
Consumption Function

When the consumption function lies above the 45

degree line, the household is dissaving.

When consumption function lies below the 45

degree line, the household has positive saving.
(simuelson norhdaus )

The saving Function

The saving function shows the relationship
between the level of saving and income.
(Simuelson Norhdhaus)
There are two savings concept that exactly
parallel to the consumption and saving
concept of APC or MPC , the average
propensity to save (APS) is the proportional to
the disposable income that house hold want to
save . Derived by dividing total desired
consumption by total disposable income: APS=
s\yd
S stands for savings and Y d stands for
disposable income

The saving Function

The marginal propensity to save (MPS) relates
the change in total desired savings to the
change in disposable income that brought it
about: MPS=change inS/change inYd, so
APC+APS = 1 or MPC or MPS =1, must sum
to unity.
( Lipsey& chrystal)
Tenth Edition

Graphical Representation of
Saving Function
Mirror image if the consumption function
It is the vertical distance between the 45 degree
line and the consumption function
Positive saving occurs to the right of point B
because the saving function is above the zerosaving line.
Point B is called Break-Even Point
Dissaving occurs to the left of point B,
because the saving function is below to zero.

Factors Influences
Consumption function
Real income
Past savings
Rate of interest

(K K David)
Wealth and consumption function
(lipsey&Chrystal)

Factors Influences Consumption

function
Objective factors
Distribution of income
Fiscal policies
Business expectations
Subjective factors
Behaviour pattern of individual
Behaviour pattern of corporate
(K K David)

Importance of
consumption function
o

Important tool of macroeconomics

analysis
The value of the multiplier( 1/1-MPC ,
less than unity)
Show crucial importance of investment
( K K David )

Saving

Consumption
Function

28,000

26,000

Consumption 24,000
expenditure

Break-even
point

Consumption

22,000
20,000

20,000

22,000 24,000 26,000

Disposable Income

28,000

600

400

Net Saving

200

Saving

0
-200

20,000

22,000

24,000

26,000

Disposable Income

28,000

The Marginal Propensity to

Consume.
The

response of consumption to changes in

income, this concept is called MPC Marginal
propensity to Consume.

The

MPC is the extra amount that people

consume when they receive an extra dollar of
disposable income.
(Ref:Samuelson Nordhaus)

The Marginal Propensity

to Save.
MPS

is defined as the fraction of an extra

dollar of disposable income that goes to
extra saving.

MPC

and MPS related like mirror images.

(Ref:Samuelson Nordhaus)

The Marginal Propensity

to Consume.
Disposable
Income (1)

Consumption
expenditure(2)

MPC
(3)

-200

Net Saving
(4)

MPS
(5)

A.24,000

24,200

200/1000

B.25,000

25,000

C.26,000

25,800

800/1000 = 0.80

200

200/1000

=0.20

D.27,000

26,600

800/1000 = 0.80

400

200/1000

=0.20

E.28,000

27,400

800/1000 = 0.80

600

200/1000

=0.20

F.29,000

28,200

800/1000 = 0.80

800

200/1000

=0.20

G.30,000
29,000
(Ref:Samuelson Nordhaus)

800/1000 = 0.80

1000

200/1000

=0.20

800/1000 = 0.80

200/1000

=0.20

A QUESTION ARISES ?

HOW TO CALCULATE MPC ?

AND

HOW TO CALCULATE MPS ?

. (Ref:Samuelson Nordhaus)

WHY MPC & MPS SAID

TO BE MIRROR IMAGES.

DISPOSABLE INCOME = CONSUMPTION + SAVING.

WHATS THE CONCEPT IF MPC HAS UPWARD &

DOWNWARD SLOPE ?
&

WHATS THE CONCEPT IF MPS HAS UPWARD &

DOWNWARD SLOPE ?
(Ref:Samuelson Nordhaus)

CONSUMPTION BEHAVIOR

DETERMINANTS OF CONSUMPTION

THE

NATIONAL CONSUMPTION
FUNCTION

ALTERNATIVES

MEASURES OF SAVING

DETERMINANTS OF CONSUMPTION:
we begin by analyzing the major forces that
affect consumer spending.

CURRENT DISPOSIBLE INCOME:

The only period when income and consumption
did not move in tandem was during (WORLD
WAR 2). When goods were scarce and
rationed and people were urged to save to
help the war effort.
(SAMUELSON)

PERMANENT INCOME AND

LIFE-CYCLE MODEL OF
CONSUMPTION:
Permanent consumption stands for that part of
consumer expenditure which the consumer
regards as permanent.
(K.K DAWETT)

According to permanent income theory

consumption responds primarily to
permanent income.
(SAMUELSON)

LIFE-CYCLE HYPOTHESIS:
It assumes that people save in order to smooth
their consumption over there life.
Hence people tend to save while working so as
to built up a nest egg for retirement and then
spend out their accumulated saving.
(SAMUELSON)

WEALTH AND OTHER

INFLUENCES
High

Interest Rate-reduces consumption

increase saving

Asset

price-increases consumption

Stock

market crash- reduces consumption

WEALTH EFFECT
The fact that higher wealth leads to higher
consumption is called WEALTH EFFECT.
(SAMUELSON)

THE NATIONAL
CONSUMPTION FUNCTION

The level of disposable income is the primary determinant

of the level of national consumption.
(SAMUELSON)

THE DECLINE SAVING RATE: National saving rate is

composed of private and government saving. A high
saving nation has a rapidly growing capital stock and
enjoys a rapid growth in its potential output. When a
nations saving rate is low its infrastructure begins to rot
away.
(SAMUELSON)

ALTERNATIVE MEASURES OF
SAVING:
Many economist believe that the wealth effect can go
a long way toward explaining the decline in saving
as measured in the national income accounts.
(AN ECONOMY IS ACTUALLY RICHER ONLY
WHEN ITS TANGIBLE AND INTANGIBLE
ASSETS INCRESE)
(SAMUELSON)

What is investment ?
Investment

is the production per unit time of

goods which are not consumed but are to be
used for future production.
For example
Tangibles.(Building or factories)
Intangibles.( years of schooling or on-the-job
training)

INVESMENT
Macroeconomists

use
the
term
INVESTMENT or Real Investment to
mean additions to the stock of productive
assets or capital goods e.g. computers, plant
equipments.

When

lever brothers Pakistan ltd builds a

new Factory or P&G Ltd builds a new factory
etc.
Ref samuelson nordhans

FINANCIAL INVESMENT
Purchases

of a piece of land, an old security

or any title of property are fall in the category
of FINANCIAL TRANSACTION or Financial
Investment because what one person is
buying, someone else is selling.

Investment

means when real capital is

purchased for productive purposes.

Ref samuelson nordhans

ROLE OF INVESMENT

1.

2.

Second major component of private spending is

Investment.
Investment plays two roles in macroeconomics.
It is a large & volatile component of spending that
leads to changes in aggregate demand & affect
Business Cycle in short run.
It leads to capital accumulation--- add to stock of
buildings & equipments to increase nations
potential output & promotes economic growth in
long run.
Ref samuelson nordhans

ROLE OF INVESMENT
In

short run: through its impact on

aggregate demand --- affects Business
Cycle.

In

long run: through the impact of capital

formation on potential output & aggregate
supply --- affect economic growth or output
growth.
Ref samuelson nordhans

DETERMINANTS OF
INVESMENT

1.

2.

Gross private Domestic Investment.

Major types of Gross Private Domestic
Investment are;
Buildings of residential structures (one
quarter of the total investment).
Investment in fixed equipment i-e. softwares
(70% of the total investment).

Ref samuelson nordhans

DETERMINANTS OF
INVESMENT
Total

Social Investment.
Total Social Investment includes:
1. Foreign Investment
2. Government Investment
3. Intangible Investment in Human Capital

Ref samuelson nordhans

DETERMINANTS OF
INVESMENT
Business

Investment --- buy capital goods.

To expect --- this act will earn them profit.
Investment in Capital Goods --- will bring
greater revenue than the cost of investment.

Ref samuelson nordhans

DETERMINANTS OF
INVESMENT

REVENUE: most important determinant of

investment.
Investment increases the overall level of GDP or
output --- more production --- earn more revenue.
Total Revenue is equal to Quantity of a commodity
sold X Price of that commodity.
TR
= Q X P
15000 = 1000 x 50

Ref samuelson nordhans

DETERMINANTS OF
INVESMENT

COST: cost of investment is another important

determinant to determine the level of investment.
Cost of investment includes not only the price of
capital goods, but
The interest rate that borrowers pay to finance the
capital, &
Tax as well that firm pays on their income.
Investment cost = price of capital good + Interest
rate + Tax
Ref samuelson nordhans

DETERMINANTS OF
INVESMENT
EXPECTATIONS:

include

Profit

expectations
Business confidence
Political condition
if political condition is
unstable investor is reluctant to invest.
investment is above all a gamble or bet.
Investment decisions hang by a thread on
expectations & forecasts.
Ref samuelson nordhans

FORCES LYING BEHIND

INVESTMENT

1.
2.
3.

Businesses invest to earn profit.

Capital goods last for many years that is
why investment decisions depend on:
Demand for the output produced by a new
investment.
Interest rate & taxes that influence the cost
of investment.
Business expectations about the state of the
economy.
Ref samuelson nordhans

Profitability of Investment
Depends on Interest Rate
(1)

(2)

(3)

(4)

(5)

(Project)
(Total
(Annual
(Cost per $1,000
Investment revenues
of Project at
in Project per $1,000
Annual Interest
$, million) invested)
rate of:) $
10%
5%
10% $
A
1
1,500
100
50
1,400
B
4
220
100
50
120
C
10
160
100
50
D
10
130
100
50
E
5
110
100
50
10
F
15
90
100
50
G
10
60
100
50
H
20
40
100
50

(6)
(Annual Net Profit
per $1,000 invested
at Annual Interest
rate of:)
5% $
1,450
170
60
110
30
80
60
-10
40
-40
10
-60
-10

(6) = (3) (4)

(7) = (3) (5)

Ref samuelson nordhans

(7)

Investment Depends upon

Interest Rate
20
15
10

0
10 20 30 40 50 60 70
Investment spending (in millions of $)
Ref samuelson nordhans

SHIFT in the INVESTMENT

DEMAND CURVE
Other

forces than interest rate also affect

level of investment.
For example, an increase in the GDP will shift
investment curve out.

Ref samuelson nordhans

SHIFT in the INVESTMENT

DEMAND CURVE
An

increase in business taxation would

depress investment, it will shift
investment demand curve in.

Ref samuelson nordhans

Shift in investment demand

function

Investment spending

Internet euphoria

Return on investment return rates

Higher taxes

Return on investment return rates

Return on investment return rates

Higher output

Investment spending

Investment spending

Ref samuelson nordhans

SHIFT in the INVESTMENT

DEMAND CURVE
A

burst of business euphoria induced by

enthusiasm about prospects for the
internet.
Changeable events of economies.
E.g. rapid growth rates for companies like
AOL Time Warner, Yahoo! And NetZero
etc.

Ref samuelson nordhans

THE END