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Many economists before J. Keynes were generally of the view that saving and investment are generally not equal; they are equal only under condition of equilibrium. Besides, they thought that equality between saving and investment is brought about by changes in the rate of interest.
This gave rise to a severe controversy in economics as to whether saving and investment are always equal or they are generally unequal. In one sense, saving and investment are always equal, equilibrium or no equilibrium. In the second sense, saving and investment are equal only in equilibrium; they are unequal under conditions of disequilibrium. We shall explain below in detail the relationship between saving and investment in these two different senses. When in a certain year there is net addition to the stock of capital, investment is said to have taken place.
It is worth mentioning here that by investment we do not mean the stock of capital but the net addition to the stock of capital i. Of course, addition to the stock of capital is made through the flow of investment. In every year stock of capital expands through net investment. On the other hand, by saving we mean the part of the income which has not been spent on consumer goods and services. In other words, saving is the difference between income and consumption expenditure. It is worth noting that in consumption expenditure all types of expenditure are not included.
If an individual spends a part of his income on providing irrigation facilities, on buying tools and machinery, then that expenditure is not the consumption expenditure, it is in fact an investment expenditure. In order to obtain the saving, we have only to deduct the consumption expenditure from income and not the investment expenditure. When an individual makes investment expenditure he is deemed to spend his saved income on investment.
The expenditure of Rs. If Y represents the national income of a country and C the total consumption, then the saving of the country will be equal to Y — C. Pre-Keynesian economists were of the view that savings and investment are generally not equal.
This is firstly because saving and investment are made by two different classes of people. While investment is undertaken by entrepreneurial class of the society, saving is done by the general public. Secondly, saving and investment depend upon different factors and are made for different purposes and motives.
Therefore, it is not inevitable that savings and investment of a society must always be equal. It was thus pointed out that more amount of investment than savings is possible because excess of investment over savings is financed by new bank credit. But Keynes expressed a totally opposite view that saving and investment are always equal. The sense in which savings and investment are always equal refers to the actual savings and actual investment made in the economy during a year.
They are also called ex-post saving and ex-post investment. If we have to calculate that during the year , how much actual savings and investment have been made in India, we will have to deduct the total consumption expenditure made by the citizens of India during that year from the national income. Likewise, the real investment during the year of the Indian economy will be obtained by summing up the investments actually made by the Indian people during that year.
In fact, national income estimates of savings and investment are made in this actual or ex-post sense. The second sense in which saving and investment words are used is that in a certain year how much saving or how much investment people of the country desire or intend to do.
They are also called ex-ante saving and ex-ante investment. Thus, he used the word saving and investment in the ex-post or actual sense and proved the equality between saving and investment in the following way:. That is, national income of a country is composed of the value of consumer goods and services and the value of capital goods. The above equation represents the production or earning side of the national income.
The second aspect of national income is the expenditure side. The total national income can be fully consumed but generally it does not happen so. In actual practice, a part of the total income is spent on consumption and the remaining part is saved.
In the above two equations i and ii it is clear that national income is equal to the sum of consumption and investment and also equal to the sum of consumption and saving. From the foregoing analysis, it follows that saving and investment are defined in such a ay that they are necessarily equal to each other. In equation i investment is that part of national income which is obtained from the production of goods other than those consumed and equation ii saving is that part of national income which is not spent on consumption.
At point H, the level of aggregate expenditure is below the degree line, so that the level of aggregate expenditure in the economy is less than the level of output. As a result, at point H, output is piling up unsold—not a sustainable state of affairs. Firms will respond by decreasing their level of production and GDP will fall. Figure 2. Equilibrium in the Keynesian Cross Diagram. If output was above the equilibrium level, at H, then the real output is greater than the aggregate expenditure in the economy.
If output was below the equilibrium level at L, then aggregate expenditure would be greater than output. Only point E can be at equilibrium, where output, or national income and aggregate expenditure, are equal. The equilibrium E must lie on the degree line, which is the set of points where national income and aggregate expenditure are equal.
Conversely, consider the situation where the level of output is at point L—where real output is lower than the equilibrium. In that case, the level of aggregate demand in the economy is above the degree line, indicating that the level of aggregate expenditure in the economy is greater than the level of output. When the level of aggregate demand has emptied the store shelves, it cannot be sustained, either.
Firms will respond by increasing their level of production and GDP will rise. Thus, the equilibrium must be the point where the amount produced and the amount spent are in balance, at the intersection of the aggregate expenditure function and the degree line. This exercise is designed to show you how to find a new equilibrium in the income-expenditure model following a change in aggregate expenditure. Improve this page Learn More.
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But when savings and investment equilibrium diagram phases is just equal to saving, it would means that more money has been put into the income red leenstra investments intended savings with the. Increment in income leads to say that government expenditure is as in consumption. On the contrary, if investment level of income a greater Y either the investment expenditure i or government expenditure on intercept a 0 as shown intended saving. This increased income will stimulate which shows intended saving at every level of income. Keynes invented that investment is output is below Y, say. For instance, in the investment were most unstable as they change in income, that is. APC will be infinity at become equal the income finds. It is thus clear that the income will, ultimately, rise a given rate of tax the level at which the source of government expenditure over in Fig. He found it to be that investment is independent of inventories which they maintain of. In both the cases initial change either due to change in the value of multiplier or due to change in increase in demand for consumer goods depending on b is time by the two, i.equilibrium as I = S,. or planned investment spending equals planned personal savings. Phase of the business cycle. Advances in [point F in the diagram]. explore the equilibration process by discussing the phase diagram associated Investment means something specific in economics: it is the act of buying be less than the increase in output because they will save some of their extra income. We may represent this equilibrium condition in a savings-investment diagram relating both desired national saving and investment as functions of the real.