Source of Income Salary wage employee worker Sales profit entrepreneur seller Dividend investor Interest rate depositors Rent room house Pension fund retirement ID: 1028011
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1. CONSUMPTION, INCOME SAVINGS AND INVESTMENT
2. Source of Income•Salary/ wage (employee/ worker)•Sales/ profit (entrepreneur/ seller)•Dividend (investor)•Interest rate (depositors)•Rent (room/ house)•Pension fund (retirement)
3. Income Consumption Food, clothes, house, vehicle, education Saving For future consumption, in financial institution
4. CONSUMPTION (C) – includes expenditure of households on food, rent, medical expenses…SAVINGS (S) – is an income received by a consumer that that is not spent on the output of firms through consumption expenditure. It is saved for the future.INVESTMENT (I) – is a purchase or investments in capital goods (non-financial product purchases - they are not consumed but used in future production) e.g. machines, buildings, new technology
5. CONSUMPTIONConsumption will create demand and then stimulate productionConsumption is main components of Aggregate Demand (AD). If AD increase, economy is expansion, if AD decrease, economy in contractionConsumption influence price of goods and services (inflation)
6. Keynes Consumption TheoryConsumption level is determined by income. If income increase, consumption will increase, if income reduce, consumption will also reduce.
7. The relationship between consumption and the level of income in called consumption function. Consumption function tells that consumption is a function of income, or in other words, consumption depends on the level of income.
8. If should be noted here that, when we talk about income, we normally mean disposable income. Disposable income is that part of total income which is available for consumption and saving. To elaborate it further, note that when a person receives income in return of factor services rendered by him/her, he/she
9. may not spend all the income on consumption only. There are certain compulsory payments he/she has to make out of the income received, such as tax to the government, fines if any etc. As a result the income available for consumption needs is reduced. Disposable income is defined as the income remained after payment of tax and fines etc.
10. If tax payment in high, disposable income will be lower and vice versa. Accordingly, the level of consumption will be affected.It should be noted that disposable income and total income will be same if tax payment and fine are not existing or zero.
11. Propensity to Consumption (how much income is consumed)PC = Consumption / IncomeMarginal Propensity to Consumption (how consumption changes with changing income)MPC = Change in Consumption / Change in Income
12. Relationship between consumption and savings Income = Consumption + SavingsThe largest part of total spending is consumption. C = f (Y)If income increases, consumption also increases BUT not as quickly as income.S = f (Y)If income increases, savings also increase BUT at the higher rate than income.
13. Propensity to Savings (how much income is saved) PC = Savings / IncomeMarginal Propensity to Savings (how savings change with changing income) MPS = Change in Savings / Change in Income
14. How is National Income divided in the economy – Keynesians TheoryY = C + S(C / Y) + (S / Y) = 1(∆C / ∆Y) + (∆S / ∆Y) = 1John Maynard Keynes developed a theory of consumption that focused primarily on the importance of people’s disposable income in determining their spending. A rise in real income gives people greater financial resources to spend or save. The rate at which consumers increase demand as income rises is called the marginal propensity to consume.
15. InvestmentInvestment is a part of Aggregate Demand that changes its value very quickly and very often.Investment can be defined as a financial cost (money) used on real capital formation(buildings, machines...).
16. Gross Investment I (gross) = I (net) + I (restitution)Net Investment net investment increases the capacity of productionRestitution Investment investment (amount of money) used on replacement and repair of worn out capital restitution investment decreases income and production. it equals to depreciation
17. Relationship between Investment and Savings Savings from Income of households are Potential Investments.Level of investment depends on Marginal Propensity to Investment.MPI (i) = Change in Investment / Change in Income
18. Investment depends on Marginal Efficiency of Capital and Interest rate (r)Marginal Efficiency of Capital compares costs on extra unit of output and expected revenue from an extra unit of output produced. Revenue can be only estimated.The higher the Marginal Efficiency of Capital, the higher the investment.The higher the interest rate, the lower the investment.
19. Investment Multiplier and AcceleratorInvestment Multiplier and Accelerator are the coefficients that show the relationship between change in Income and change in Investment.Investment Multiplier (k) k = ∆Y / ∆ I ∆Y = k. ∆IIt means: increase in investment leads to even more increase in income. Increase in Savings leads to decrease in multiplier.
20. (∆C / ∆Y) + (∆S / ∆Y) = 1 k = 1 / (1 – (∆C / ∆Y)) = 1 / (∆ S / ∆Y)Multiplier Effect works in the economy only if the factors of production are not used to maximum level of production
21. Investment Accelerator(a)It is the coefficient that shows how change in Income leads to change in Investment. ∆I = a.∆YAccelerator Process works only in connection with Investment which increases the capacity of production..
22. If there were no increase in Income, there would not be any increase in Aggregate Demand and it will be enough to replace worn out capital and not increase the capacity of production.Only if there was an increase in Income and Aggregate Demand it would lead to increase in investment and production of goods and services.
23. QuestionGiven, the consumption functionC = 150 + 0.6Y, where C = consumption expenditure, Y = income and investment expenditure = Rs 2,000. Calculate:(i) Equilibrium level of national income(ii) Consumption at equilibrium level of national income(iii) Saving at equilibrium level of national income
24. Solution(i) Given, C = 150 + 0.6Y and I = 2,000At the equilibrium level,Y = C + I⇒ Y = 150 + 0.6Y + 2,000 ⇒ Y = 2,150 + 0.6YY - 0.6Y = 2,150 ⇒ 0.4Y = 2,150Y=2,150 ∕0.4=5,375
25. (ii) Consumption, C = 150 +0.6(5,375) = 150 + 3,225 = 3,375
26. (iii) We know that, Y = C + S⇒ S = Y - C = 5,375 - 3,375 = 2,000Alternatively, Given : C = 150 + 0.6Y,S = -150 + 0.4Y (∵ MPC = 0.6, accordingly MPS = 1 - 0.6 = 0.4)Or, S = -150 + 0.4(5,375)= -150 + 2,150 = 2,000.
27. QuestionC = 50 + 0.5 Y is the consumption function where C is consumption expenditure and Y is National Income and investment expenditure is 2,000 in an economy. Calculate: (i) Equilibrium level of (national) income; (ii) Consumption expenditure at equilibrium level of (National) income.
28. Solution(i) At equilibrium,AS=ADY= C+I=> Y= 50 + 0.5 Y + I=> Y - 0.5 Y = 50 + 2,000=> 0.5 Y = 2,050=> Y = 2,050/ 0.5 = 4,100
29. (ii) Consumption Function, C = 50+ 0.5 Y where Y in the income in the economy.So at national income 4,100 , consumption expenditure isC = 50+ 0.5 ( 4,100)= 50 + 2,050= 2,100
30. QuestionC = 100 + 0.4 Y is the Consumption Function of an economy, where C is Consumption Expenditure and Y is National Income. Investment expenditure is Rs.100. Calculate: (i) Equilibrium level of National Income; (ii) Consumption expenditure at equilibrium level of national income.
31. Solution At equilibrium,AS=ADY= C+I=> Y= 100 + 0.4 Y + I=> Y - 0.4 Y = 100 + 100=> 0.6 Y = 200=> Y = 200/ 0.6 = Rs.334
32. (ii) Consumption Function, C = 100+ 0.4 Y where Y in the income in the economy.So at national income Rs. 334, consumption expenditure isC = 100+ 0.4 ( 334)= 100 + 133.6= Rs. 233.6.
33. QuestionFrom the following information about an economy, calculate (i) its equilibrium level of national income, and (ii) saving at equilibrium level of national income. Consumption function: C = 200 + 0.9 Y (where C = consumption expenditure and Y = national income) Investment expenditure: I = 3,000.
34. Solution(i)At equilibrium level of output,AS=ADY= C+I=> Y= 200 + 0.9 Y + 3,000=> Y - 0.9 Y = 200+ 3,000=> 0.1 Y = 3,200=> Y = 3,200/ 0.1 = 32,000 crores(ii) At equilibrium level of Income, consumption expenditure isSavings = Investment = 3000 crores
35. QuestionIn an economy S = -50 + 0.5 Y is the saving function (where S = saving and Y = national income) and investment expenditure is Rs. 7,000. Calculate: (I) Equilibrium level of national Income. (II) Consumption expenditure at equilibrium level of national income.
36. S= -50+0.5 Y C+S=Y=> C = Y-S= Y - (-50+0.5 Y)= Y + 50 - 0.5 Y= 50 + 0.5 YHence, C = 50 + 0.5 YAt equilibrium level of output,AS=ADY= C+I=> Y= 50+ 0.5 Y + I=> Y - 0.5 Y = 50+ 7000=> 0.5 Y = 7,050=> Y = 7,050/ 0.5 = 14,100 rupees
37. At equilibrium level of Income, consumption expenditure is 50 + 0.5 ( 14,100) = 50 + 7,050 =Rs. 7,100