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Savings, Investments and Consumption

Importance of Saving

(i) Security Purpose:
Some people save towards their old age, while others save in order to guard against unforeseen circumstances like retrenchment, fire disaster, sickness, etc.
(ii) Speculative Reasons:
Some people save with the hope to buy more when prices of goods and services fall in the near future.
(iii) Improved Standard of Living:
Some people save for the purpose of maintaining a high and constant standard of living. Others save to buy property like cars, television, houses, etc.

Concepts of Savings, Investments and Consumption

Savings: Savings are money earned by all factors of production as income but not spent on the consumption of goods and services. This is usually income after tax, which is known as disposable income and is made up as follows:
Y     =    C+S

Y     =     Income
C    =     Consumption
S     =     Savings

Savings can be expressed mathematically as:
S     =     Y-C

i.e. savings are income less consumption. Note that savings are withdrawals or leakages from the circular flow of income. However, some of the savings are injected into flow as investments.

Types of Savings

(i) Individual or Personal Savings
(ii) Business Savings
(iii) Governmental Savings

Individual Savings: These are made up of savings of various individuals who for one reason or the other decided to curtail or reduce their consumption in favour of savings.

Determinants of Individual Savings

(i) Income Size:
When the size of the income of an individual is large, his savings will also be large and vice versa.

(ii) Presence of Financial Institutions and Banks:
The presence of many banks and financial institutions offering various attractive services and products in a town, encourages peoples to save.

(iii) Rate of Interest:
If the interest rate is high, people will prefer to save rather than spend their income and vice versa, all things being equal.

(iv) Social and Political stability:
A socially and politically stable country will have more people saving their money in the banks, than one filled with violence and political instability.

(v) Government Policy:
The government can force people to save by making it mandatory or compulsory to do so. This happened in 1984 when the military government decreed the establishment of the National Economic Emergency Fund. The decree gave the government the authority to make compulsory deductions from workers’ salaries for a period of fifteen months.

(vi) Business Savings:
These are monies put or set aside by business units.

Factors that influence Business Savings

(i) The Size of the Profit:
The higher the profit level, the higher the savings level, and vice versa.

(ii) Government Policy:
If government increases the tax imposed on dividends, or freezes the payment of dividends, this will increase business savings, profits which should have been distributed and paid as dividends will be saved by this policy.

(iii) Expected Increases in Prices:
This leads to increases in profit level thus encouraging firms to save in order to buy investments at current prices rather than in the future when prices will be expected to rise.

(iv) Government Savings: Government saves when it has a budget surplus. This occurs when expected income exceeds expenditure.

Reasons for Savings
Individuals, businesses and government save for various reasons:

(i) To improve their social standing, some people save to have wealth and to be counted among the rich in the society.
(ii) Some people save against their retirement, i.e. they save in order to have something to fall back on during their old age, and for unforeseen circumstances.
(iii) Some people save to acquire fixed assets that will improve their social standings in the society. At their death the assets are inherited by their children and their descendants. These include cars, houses, electronic instruments, etc.
(iv) Businesses save to acquire money for expansion purposes.
(v) People save because they are tight fisted, i.e. they do not want to spend because they are misers.

Investment is expenditure on capital goods for the purpose of further production. Investment can also occur when goods are bought and added to the current stock of capital goods. Capital goods include houses, plants and machineries, factories and raw materials.

Note that many people regard the purchase of shares and securities in companies as investment. This is a mere transfer of ownership from one person to another. Investment will only take place when companies issue or offer for sale new shares to the public. The money realised from the sales is used for the purchase of capital goods like plants, machinery or house, etc.

Money for investment comes from banks, financial institutions, friends and relations or personal savings.

Note that investments are injections into the circular flow of income.

Factors that Influence Investments

(i) The Size of Income:
The higher the amount earned, all things being equal, the higher the level of investments.

(ii) Level of Savings:
Increases in the level of saving also lead to increases in the rate of investments. This means a reduction in the level of consumption will lead to higher savings and higher investments.

(iii) Interest Rate:
If the interest rate is high, investors will find it unprofitable to borrow for investment. Investment level will be low. On the other hand if the rate is reasonable, the level of investment will be high, as many investors will borrow money for the sole purpose of investing in the economy.

(iv) Government Policy:
If government policy towards investment is favourable, it will give tax concessions, reduce taxes, reduce interest rates and even grant subsidies so as to increase the investment level in the country. The opposite occurs if it wants to reduce investment level especially in areas where production of such goods are harmful to one’s health e.g. tobacco production.

(v) Political and Social Stability: A politically and socially stable economy will attract investors both local and foreign, thus increasing the investment level of the country, and vice versa.

Consumption means spending money on the purchase or use of goods and services that will satisfy human wants. These goods are usually known as consumption goods and have a life span of not more than one-year. Consumption goods are not used for the production of further goods.

Factors that Determine Total Consumer Spending

(i) Size of income:
A high-income earner spends more on consumption than a low income person does. Therefore, the higher the size of one’s income ceteris paribus, the higher the amount of goods and services consumed.

(ii) Savings:
People do not spend only their current income, but also past and even future income. The high saving level also means a high level of consumption e.g. when an individual buys a new car, he spends both his past and current incomes and some part of his future incomes.

(iii) Easy Credit:
Availability of easy facilities increase the level of consumption while the opposite is the case where credit facilities are very hard.

(iv) introduction of New High Quality Goods into the Market:
This influences consumption positively, for instance, the introduction of the handsets i.e. mobile telephones, computer services, high quality video CD’s have led to an enormous increase in the level of consumption of households.

(v) High Profits:
The higher the profit earned, the higher will be the consumption level of films.

(vi) Role of Expectation:
When there is a fear of future increase in prices, this stimulates or influences people to buy more at current prices, thereby increasing the level of consumption.

(vii) Assets Owned:
During the period of depression many assets such as houses, land and some factories remain idle even labour also remains unemployed. If there is an upward turn, the economy picks up, factories start production, idle lands become used, unemployed labour becomes employed, and unoccupied houses become rented apartments. The increased income will promptly lead to increase in consumption.

(viii) Government Policy: A high level of income tax, purchase tax, etc., has the effect of reducing consumption, and vice versa.

The Relationships between Savings, Consumption, Investment and Income
The relationship between income, savings, consumption and investment can be expressed mathematically as follows:
Y    =     C+S or Y   = C + I


Y     = Income
C     = Consumption
S     = Savings
I      = Investments

It is assumed that savings is equal to investments i.e. S = I

It is assumed that any part of income not consumed is saved, secondly, that all savings are invested hence, the two equations above. It is believed also that even money borrowed for investment is money saved by someone or an institution. Hence the assumption that savings is equal to investments. Therefore, the amount of income not consumed is what is saved. The higher the level of consumption, the lower the level of the savings and therefore the lower the level of investments in a country, and vice versa. Therefore, a country’s income is made up of its savings, consumption and investment, as shown in the income equation above.