What is Savings?
Savings denotes the gap between income and expenditure or consumption. Whatever is not consumed out of disposable income is savings.
The economy’s savings equation is: Savings = Personal Disposable income – consumption
Table of Contents
- 1 What is Savings?
- 2 Some Useful Concepts on Savings
- 3 Motives for Saving
- 4 Saving and Rate of Interest
- 5 Use of the Concept of Saving
- 6 Savings and Investment
- 7 Types of Investment
The concept of saving is one of the very important concepts in economics and finance. Economic objectives like price stability, maintaining high levels of income and employment and high rates of economic growth have a close relationship with the concept of saving.
The concept of saving helps to analyse many macro-economic aspects such as fluctuations in economic activity between propensity and recession, the process of economic growth and the method of financing economic growth and the method of financing gross domestic capital formation.
The term personal disposable income means the amount of money an individual retains after he has made all his necessary expenditures. This money is usually kept in banks or used for investment through which the saver earns an interest income or investment returns. It is necessary for an individual or an economy to meet any unforeseen expense.
Some Useful Concepts on Savings
Savings is an important component of economic activity. The savings rate can accelerate as well as deter economic growth.
On an individual level, savings is calculated by a personal (or family) income less their consumption and tax paid. This is known as personal savings. Personal savings may be a result of binding contracts like pension schemes or any investment. Or, it may be an outcome of negative expectation about future income.
On a macro level, the aggregate savings of any economy is a much more complex calculation. The savings by a country is known as national savings. It is the summation of personal, business and state savings.
Saving Vs Savings
There is a significant difference between the terms ‘saving’ and ‘savings’. The saving is a flow concept and refers to the addition of the stock of capital (wealth) that occurs over a period of time. Whereas savings refers to the holding of wealth in some form, usually financial claims at a point of time. Hence, savings is a stock concept.
Motives for Saving
There are several motives which induce- people to save. They can be grouped under two headings:
Power to save
Power to save depends upon the level of income which a person earns. In case of a nation, power to save depends on proper utilization of natural resources. It is because when the income is low, then almost the whole amount is spent on meeting the bare necessities of life, so saving is very nominal. But in case of high income, saving is also high because there is surplus income overconsumption.
Will to save
The willingness to save is influenced by subjective considerations.viz;
- Foresight: People save money as a provision against some unforeseen circumstances which might arise in the future. Few others accumulate wealth for their dependants. All these prudential considerations can be constituted under the heading foresight.
- Social and political considerations: Wealth gives power over other men in the economic sphere and also political and social influence. The desire of prestige, power and respect in social sphere and political life actuates human being to save
- Temperamental considerations: There some persons who save neither for their families nor for their own use but merely because they have acquired a sort of mania for accumulation of wealth for its own sake.
- Security of Life and Property: If there is security of life and property in a country the saving is encouraged.
- Facilities for Investment: If facilities of profitable investment are available, then saving is stimulated.
- Monetary Stability: Monetary stability also plays a very important part in inducing the people to save money. If people apprehended a sharp fall in the value of money, then saving is discouraged and if the value of money is expected to rise, the saving is encouraged.
Saving and Rate of Interest
Interest rate is one of the very important factors which exercises influence on the volume of saving. Interest rate is defined as the opportunity cost of holding money in hands, i.e., the amount foregone for keeping the money in hand. It is the incentive that propels any person to deposit money in banks. If the rate of interest is high, it generally, induces people to save more money and if it is low, the saving is discouraged.
However, there are few people who will try to save more even when the interest rate is low or save less when the interest rate is high just to provide for themselves a certain annual income for their old age or for their dependants.
For example, a man wishes to have an annual income of Rs. 4,000 after retirement If, we suppose the annual rate of interest is 10%, then he has to save Rs. 40,000, to get an income of Rs. 4,000. If the rate of interest falls down to 5%, then he has t0 save Rs, 80,000 to get the desired sum of Rs. 4,000. There will of course be many people who will go on saving whatever the rate of interest. Thus it can be said that saving is encouraged when the interest rate is high and discouraged when it is low.
Use of the Concept of Saving
The concept of saving helps to analyze many macro-economic aspects such as;
- Fluctuations in economic activity between propensity and recession
- The process of economic growth
- The method of financing economic growth
- The method of financing gross domestic capital formation.
Changes or fluctuations in economic activity may occur when investment spending is greater or smaller than the savings at a given level of income. Moreover, the resources going into the productive process, i.e., capital formation, may have a direct relationship with economic growth.
In other words, growth in economic activity may result either from widening the application of capital (capital widening) or intensifying its user, utilizing more capital per unit of labour and output ( capital deepening).
Lastly, all economic activities; agriculture, industrial, or services depend on the availability of financial resources. These resources needed for economic growth must be generated. The amount of financial resources and the volume of capital formation depend upon the intensity and efficiency with which savings are encouraged, gathered and directed towards investment.
An institutional mechanism i.e. the financial system performs this role to aid economic growth. As more saving moves through the financial system, the financial depth increases.
Savings and Investment
Savings is often equated with investment in any economy. The savings from households, companies as well as government are transferred to those who require it for investment purposes via financial intermediaries like, banks and other financial institutions. Such investments generally contribute to economic growth by adding to the capital base of the nation.
When the term investment is used in economics, it refers to the expenditure incurred by individuals and businesses on the purchase of new plant and machinery, the building of new houses, factories, schools, construction of roads etc. It is in other words, in the acquisition of new physical capital. Investment can be called as the addition to the capital stock of the economy. In brief, it includes the following kinds of expenditures.
- Stocks or inventories: The inventories expenditures incurred by businesses on the purchase of new raw material, semi finished goods and on stock of unsold goods (inventories) are counted as investment.
- Fixed Capital: The expenditure made on new plants and machinery vehicles, houses facilities, etc. are also included in investment. In the words of J. M. Keynes Investment means real investment which refers to increase in the real capital stock of the economy.
Types of Investment
- Autonomous Investment
- Induced Investment
- Financial Investment
- Real Investment
- Planned Investment
- Unplanned Investment
- Gross Investment
- Net Investment
Investment which does not change with the changes in income level is called as Autonomous or Government Investment. The investment which is not influenced by changes in national income is called autonomous investment.
In other words, an autonomous investment is independent of the level of national income. As regards the size of the autonomous investment, it is influenced by many basic factors Such as increase in population, manpower, level of technology, the role of interest, the expectations of future economic growth and the role of capacity utilization etc.
Autonomous Investment remains constant irrespective of income level, which means even if the income is low, the autonomous, Investment remains the same. It refers to the investment made on houses, roads, public buildings and other parts of Infrastructure. The Government normally makes such a type of investment.
Investment which changes with the changes in the income level is called as Induced Investment. Investment in the economy is influenced by the income or output of the economy. The larger the national income, the higher is the investment. Induced investment is the change in investment which is induced by the change in the national income.
Induced Investment is positively related to the income level. That is, at high levels of income entrepreneurs are induced to invest more and vice-versa. At a high level of income, Consumption expenditure increases this leads to an increase in investment of capital goods, in order to produce more consumer goods.
An investment made in buying financial instruments such as new shares, bonds, securities, etc. is considered as a Financial Investment. However, the money used for purchasing existing financial instruments such as old bonds, old shares, etc., cannot be considered as financial investment.
It is a mere transfer of a financial asset from one individual to another. In financial investment, money invested for buying of new shares and bonds as well as debentures have a positive impact on employment level, production and economic growth.
An investment made in new plant and equipment, construction of public utilities like schools, roads and railways, etc., is considered as Real Investment. Real investment in new machine tools, plant and equipments purchased, factory buildings, etc. increases employment, production and economic growth of the nation. Thus real investment has a direct impact on employment generation, economic growth, etc.
Investment made with a plan in several sectors of the economy with specific objectives is called as Planned or Intended Investment. Planned Investment can also be called as Intended Investment because an investor while making investment makes a concrete plan of his investment.
Investment done without any planning is called as an Unplanned or Unintended Investment. In an unplanned type of investment, investors make investment randomly without making any concrete plans. Hence it can also be called an Unintended Investment. Under this type of investment, the investor may not consider the specific objectives while making an investment decision.
Gross Investment means the total amount of money spent for creation of new capital assets like Plant and Machinery, Factory Building, etc. It is the total expenditure made on new capital assets in a period.
Net Investment is Gross Investment less (minus) Capital Consumption (Depreciation) during a period of time, usually a year. It must be noted that a part of the investment is meant for depreciation of the capital asset or for replacing a worn-out capital asset. Hence it must be deducted to arrive at net investment.