Theory of saving in Saving function.pptx

Saving functionshow us the mathematical relation between Saving and Income

1. Indira Gandhi Krishi Vishwavidyalaya,Raipur An assignment on “Saving function and Theory of Saving” Submitted to Dr. Ravi Shrey Dept. of Agricultural Economics Submitted by Ankur Jaiswal PhD 1 st year

2. Saving Function: Saving function refers to the functional relationship between saving and national income. S = f (Y) Where, S= Saving, Y = National Income, F= Functional relationship

3. Saving Schedule Income (Y) Rs Consumption (C) Rs Saving (S = Y – C) Rs 40 -40 100 120 -20 200 200 300 280 20 400 360 40 500 440 60 600 520 80

4. Important Observations Starting point of Saving Curve: Saving curve (SS) starts from point S on the Y-axis, indicating that there is negative saving (equal to autonomous consumption) when national income is zero. Slope of curve: SS has a positive slope, which indicates the positive relationship between savings and income. Break- even point (S=0): Saving curve crosses the X-axis at point R which is known as break-even point at this point, saving is zero Positive saving: After the break even point, saving is positive.

5. Types Of Propensity To Save Average Propensity To Save (APS) Marginal Propensity To Save (MPS)

6. Average Propensity to Save (APS): • APS refers to the ratio of saving to the corresponding level of income. APS = Savings (S) / Income (Y)

7. Income (Y) Rs Saving (S) Rs APS (S/Y) Rs -40 - 100 -20 -20/100 = -0.20 200 0/200 = 0 300 20 20/300 = 0.06 400 40 40/400 = 0.10

8. Important Points about APS 1. APS can never be 1 or more than 1: As saving can never be equal to or more than national income. 2. APS can be 0: APS= 0 as savings are zero at the income level of 200 crores. This point is known as Break-even point. 3. APS can be negative or less than 1: At income levels which are lower than the break-even point, APS can be negative as there will be dissavings in the economy. 4. APS rises with increase in income: APS rises with increase in income because the proportion of income saved keeps on increasing.

9. Marginal Propensity to Save (MPS): MPS refers to the ratio of change in saving to change in total income. MPS = Change in Savings (S)/ Change in Income (Y )

10. Income (Y) Rs Savings (S) Rs Change in Saving Change in Income MPS (Change in Saving/ Change in Income) -40 - - - 100 -20 20 100 20/100 = 0.20 200 20 100 20/100 = 0.20 300 20 20 100 20/100 = 0.20 400 40 20 100 20/100 = 0.20

11. MPS varies between 0 and 1 if the entire additional income is saved, i.e. C =0 then MPS = 1. However, if the entire additional income is consumed, i.e. S-0,then MPS = 0. In normal situations, value of MPS varies between 0 and 1.

12. Relationship between APC and APS: The sum of APC and APS is equal to one. 1 = APC + APS Relationship between MPC and MPS: The sum of MPC and MPS is equal to one. 1 = MPC + MPS

13. Theories of Savings Lifecycle theory of savings Classical theory of Savings Neo Classical theory of Savings Keynesian theory of saving katona theory of savings

14. Lifecycle theory of savings The life-cycle theory of savings, also known as the life-cycle hypothesis. IT is an economic concept that suggests individuals plan their consumption and savings over their entire lifetime, aiming to maintain a stable level of well-being both during their working years and in retirement. This theory was developed by economists Franco Modigliani and Richard Brumberg in the 1950s and later expanded upon by Modigliani himself and his colleague Albert Ando.

15. Key features of the life-cycle theory of savings include: Consumption over the Lifecycle : The theory posits that individuals seek to maintain a relatively constant standard of living throughout their lives, adjusting their consumption patterns in response to changes in income, age, and other factors. Generally , people tend to borrow when they are young and their income is low (e.g., during their education), save during their peak earning years, and then dis-save (use savings) during retirement when their income decreases . Consumption over the Lifecycle : The theory posits that individuals seek to maintain a relatively constant standard of living throughout their lives, adjusting their consumption patterns in response to changes in income, age, and other factors. Generally , people tend to borrow when they are young and their income is low (e.g., during their education), save during their peak earning years, and then dissave (use savings) during retirement when their income decreases.

16. Precautionary and Bequest Motives : The theory acknowledges that individuals may save for reasons beyond their own consumption needs. This includes saving for precautionary reasons, such as unexpected expenses or income fluctuations, as well as saving to leave an inheritance or bequest to future generations . Implications for Policy : The life-cycle theory has important implications for economic policy, particularly in areas such as retirement planning, social security, and taxation. For instance, policymakers may design retirement savings programs or pension systems that encourage individuals to save during their working years to ensure financial security in retirement . Overall, the life-cycle theory of savings provides a framework for understanding how individuals allocate their resources over their lifetimes to achieve their consumption and savings goals, taking into account factors such as income, age, and risk preferences. It remains a central concept in economics for analyzing household behavior and designing effective policy interventions related to savings and retirement planning.

17. The Classical Theory of Savings: The classical theory of savings emerged within the broader framework of classical economics, which dominated economic thought from the 18th to the early 20th centuries. Classical economists believed in a self-regulating market system where supply and demand would naturally lead to economic equilibrium. Savings played a crucial role in this system, driving investment and ultimately fostering economic growth.

18. Key Ideas in Classical Savings Theory Savings as Abstinence: Classical economists viewed saving as a form of "abstinence" – choosing not to consume current income but to set it aside for future use. This act of delaying gratification was seen as a necessary virtue for economic progress. Savings and Investment: Savings provided the pool of resources for investment in capital goods like machinery, factories, and infrastructure. This investment in turn led to increased productivity and economic output. The Role of Interest Rates: Higher interest rates offered a greater reward for saving, potentially incentivizing individuals to save more and channel those funds into productive investments.

19. Criticisms and Modern Relevance Limited Role for Government: Classical theory generally advocated for minimal government intervention in the economy. This meant less focus on policies that might encourage saving or direct investment. Overlooked Consumption: The theory primarily focused on the positive aspects of saving and investment, potentially neglecting the role of consumption in driving economic growth. Modern Adaptations: While some aspects of the classical theory have been challenged by Keynesian economics, the core idea of saving driving investment and economic growth remains relevant in modern economic models.

20. Neoclassical Theory of Saving: The neoclassical theory of savings emerged within the broader framework of neoclassical economics, which dominated economic thought in the mid-20th century. Neoclassical economists built upon the ideas of classical economics but incorporated more rigorous mathematical modeling and a focus on individual rationality.

21. Key Principles of Neoclassical Savings : Rational Decision-Making: Individuals are assumed to make rational choices based on their preferences and constraints. This includes decisions about saving and spending. Time Preference and Intertemporal Choice: Neoclassical theory acknowledges the concept of time preference – the tendency to value present consumption more than future consumption. Individuals make choices about saving and investment by weighing the current value of forgoing consumption against the future benefits of that saving. Interest Rates and Savings Decisions: Higher interest rates offer a greater incentive to save, as they represent the return on delaying consumption. This relationship between interest rates and savings is a core tenet of neoclassical theory.

22. Savings, Investment, and Economic Growth: Savings Fuel Investment: Neoclassical theory maintains that higher saving rates lead to a larger pool of funds available for investment. Investment Drives Productivity and Growth: Businesses use these savings to invest in capital goods like machinery and technology, ultimately leading to increased productivity and economic growth. The "Loanable Funds" Market: Neoclassical theory posits the existence of a "loanable funds" market where savers supply funds and businesses demand them for investment purposes. The interest rate acts as the equilibrium price that balances supply and demand in this market.

23. Criticisms and Modern Considerations Limited Role for Government: Similar to classical theory, neoclassical theory generally favors minimal government intervention in the economy, including policies aimed at promoting saving or directing investment. Oversimplification of Saving Behavior: The theory's focus on rational decision-making may oversimplify real-world saving behavior, which can be influenced by factors beyond pure economic calculations. Modern Economic Models: While incorporating aspects of neoclassical theory, modern economic models often acknowledge the complexities of saving decisions and the potential role of government policies in shaping economic outcomes .

24. Keynesian Theory of Savings: John Maynard Keynes, a prominent economist of the 20th century, challenged the prevailing classical and neoclassical views on savings. He argued that saving did not automatically translate into economic growth. The Keynesian theory of savings, developed by John Maynard Keynes, diverges from classical and neoclassical perspectives by introducing unique concepts and emphasizing the role of aggregate demand in shaping economic outcomes.

25. Key features of Keynesian Views: Propensity to Save : Keynes introduced the notion of the propensity to save, influenced by factors like income and expectations, which determines the portion of income individuals save rather than spend . Marginal Propensity to Consume (MPC) : Alongside the propensity to save, Keynes highlighted the MPC, representing the fraction of additional income that individuals spend on consumption, showing the inverse relationship between saving and consumption . Paradox of Thrift : Keynes argued that while saving may be rational for individuals, widespread increases in saving can lead to reduced aggregate demand, resulting in economic contraction—a concept known as the paradox of thrift.

26. Key features of Keynesian Views: Role of Aggregate Demand : Unlike classical and neoclassical economists who emphasized saving's automatic translation into investment and growth, Keynes underscored the centrality of aggregate demand, driven by consumption, investment, government spending, and net exports, in determining economic activity and employment levels . Policy Implications : Keynesian economics advocates for government intervention, particularly through fiscal policy, to stabilize the economy during periods of low private demand. This intervention involves increasing government spending to stimulate economic activity and employment.

27. K atona theory of savings The Katona theory of savings is an economic theory developed by George Katona , a Hungarian-American economist and psychologist. Katona made significant contributions to the field of behavioral economics, particularly in understanding consumer behavior and decision-making processes. His theory of savings focuses on psychological and behavioral factors that influence individuals' saving behavior. Ability to save Willingness to save

28. Key Features : Psychological Factors : Katona emphasized the importance of psychological factors, such as attitudes, beliefs, perceptions, and expectations, in shaping saving behavior. He argued that individuals' saving decisions are influenced not only by objective economic factors, such as income and interest rates, but also by their subjective perceptions of their financial situation and future prospects . Subjective Expected Utility : Katona introduced the concept of subjective expected utility, which refers to individuals' subjective assessments of the benefits and costs associated with saving. He suggested that individuals weigh the potential benefits of saving, such as financial security and future consumption, against the immediate costs, such as reduced current consumption and forgone opportunities.

29. Key Features : Financial Satisfaction and Dissatisfaction : Katona proposed that individuals experience feelings of satisfaction or dissatisfaction with their financial situation, which can affect their saving behavior. For example, individuals who feel financially secure and optimistic about the future may be more inclined to save, whereas those who feel financially stressed or pessimistic may be less motivated to save. Social Norms and Peer Influence : Katona recognized the influence of social norms and peer behavior on saving decisions. He argued that individuals may be influenced by the saving behavior of their social network, such as family, friends, and colleagues. Social norms regarding saving and spending can shape individuals' attitudes and behaviors toward saving. Survey Research : Katona conducted extensive survey research to study consumer attitudes and behavior, including saving behavior. He developed survey instruments, such as the Consumer Sentiment Index, to measure consumer confidence and economic expectations. By analyzing survey data, Katona sought to uncover the underlying psychological and behavioral factors driving saving decisions.

30. Refernces Keynes, John Maynard, (1883-1946). The General Theory of Employment, Interest and Money. London :Macmillan, 1936 .   George, Katona , (1951 ). Psychological Analysis of Economic Behavior, McGraw-Hill ,   New York. Ando, Albert, and Franco Modigliani. “The Life Cycle Hypothesis of Saving: Aggregate Implications and Tests.”  American Economic Review  53 (March 1963): 55–84.