Savings Strategies: Invest In Your Future

The concept of savings being equal to investments is a fundamental principle in economics, specifically in the context of macroeconomic analysis. This relationship is often referred to as the savings investment identity or the savings investment equality. The idea is that, in a closed economy, the amount of money saved is equal to the amount of money invested in new capital. This can be expressed as an equation: Savings (S) = Investments (I).

This equation holds true because of how the variables are defined. Savings refer to the excess of disposable income over consumption expenditure, while investments refer to the purchase of new physical capital, such as machinery or inventory. In a closed economy, where there is no international trade, the Gross Domestic Product (GDP) is equal to the total income or expenditure, which includes consumer spending, government spending, and investments. Therefore, when consumption and government spending are subtracted from GDP, what remains is equal to the amount saved and invested.

This relationship between savings and investments is important for understanding a country's economic health and potential for growth. It also highlights the interconnectedness of individual and collective economic behaviours. An increase in savings can lead to a decrease in consumption, which can impact income and employment. This is known as the paradox of thrift.

Savings and investment equality is derived from the general equality of aggregate demand and aggregate supply

In Keynes' 'General Theory', the equality of saving and investment is derived from the general equality of aggregate demand and aggregate supply, or Y = C + I. Here, Y is the total income or expenditure of the economy, C is consumer spending, and I is investment. This equation signifies that equilibrium in the economy is achieved when total demand is equal to aggregate supply.

Keynes defined saving and investment in a way that they are always equal, which is known as accounting equality or logical identity. National output consists of consumption goods and investment goods, so O = C + I. Similarly, national income is divided between consumption expenditure and saving, so Y = C + S. Since O = Y, we can rearrange to make C + I = C + S, or I = S.

However, Keynes also stated that saving equals investment only when the economy is in equilibrium. This is known as functional equality. In a dynamic economy with changing variables, saving and investment may be equal but not in equilibrium. For example, if there are consumption-expenditure production lags, saving and investment will not be in equilibrium. Equilibrium is only achieved once these lags have been overcome.

Saving and investment equality is also called logical identity

Saving and investment equality, also known as the saving identity or saving-investment identity, is a concept in national income accounting. It states that the amount saved in an economy will be the amount invested in new physical machinery, new inventories, and the like.

This equality is also called a logical identity because it is true by definition. The logic behind this equality is as follows: the national output consists of (i) consumption goods and (ii) investment goods (O = C + I). Similarly, national income is divided between consumption expenditure and saving (Y = C + S). However, we know that by definition, O = Y, therefore, C + I = C + S or I = S.

This equality between saving and investment can be expressed in another way: savings are defined as the excess of income over consumption, i.e., S = Y – C. Meanwhile, investment is defined as income minus consumption or I = Y – C. Hence, S = I (because both are equal to Y – C).

This equality is useful for several reasons. Firstly, it helps explain the 'paradox of thrift', which states that if all people in a community try to save more, the total or aggregate savings will not rise. Secondly, the identity (S = T) points to the unfavorable outcomes that result from attempting to save more than investment at a particular time. Finally, the saving-investment equality sheds light on and paves the way for determinate or functional equality.

Saving equals investment only in equilibrium

Saving equals investment only when the economy is in equilibrium. This is known as functional equality. In a closed economy, savings are equal to investments. However, this equality does not necessarily imply equilibrium.

In his 'General Theory', Keynes states that saving equals investment only in equilibrium. This is in contrast to the classical position, which holds that equality between saving and investment is always brought about at full employment income.

Keynes' theory states that equality between saving and investment is brought about by changes in income, rather than the rate of interest. When investment exceeds saving, income will rise until the saving out of the higher income is equal to the increased investment. Similarly, when saving exceeds investment, income will fall until the saving out of the lower income is equal to the reduced investment.

The accounting equality of saving and investment holds regardless of whether the economy is in or out of equilibrium. This is a logical identity, where the national output consists of consumption goods and investment goods, and national income is divided between consumption expenditure and saving.

Classical economists also talked of saving and investment being equal to each other

Classical economists, including Prof. Hansen, also acknowledged the equality between saving and investment. However, their approach and views on the matter differ from those of Keynes.

Firstly, classical economists believed that the equality between saving and investment was brought about by the rate of interest. They argued that when savings tend to exceed investments, the rate of interest falls to discourage savings and encourage investment. Similarly, when investment exceeds savings, the rate of interest rises to discourage investment and increase savings. In this way, the disequilibrium between savings and investment is corrected by changes in the rate of interest.

Secondly, classical economists believed that this equality was always brought about at full employment income.

Keynes disagreed with both these propositions. He argued that the equality between saving and investment is brought about not by the rate of interest, but by changes in income. He also believed that savings and investment can be equal at less than full employment.

The equality between saving and investment has been the cause of great debate and controversy

In his 'General Theory', Keynes says both. At some points, he writes that saving always equals investment, while in other places, he states that saving equals investment only in equilibrium. This dual approach has been a source of confusion.

The main source of confusion arose from critics failing to realise that while saving and investment are always equal, they are not necessarily in equilibrium. If an economy is in motion and variables are in a normal functional relationship, then saving and investment are equal and may also be in equilibrium. However, if there are consumption-expenditure production lags, saving and investment, though equal, will not be in equilibrium.

Classical economists also talked of saving and investment equality, but they believed this was brought about by the rate of interest. Keynes, on the other hand, held the opinion that equality was brought about by changes in income. Classical economists also believed that this equality always occurred at full employment income, while Keynes believed it could happen at less than full employment.

The equality between saving and investment can be expressed as Y = C + I, where Y = national output/income, C = consumption goods, and I = investment goods. It can also be expressed as Y = C + S, where S = savings. So, C + I = C + S, or I = S.

This equality is useful in explaining the 'paradox of thrift', which states that if everyone tries to save more, the total savings will not rise. This is because one person's saving is another person's reduced income. So, if one person saves more, another person's income is lowered, and they will not be able to save more.

In summary, the equality of saving and investment has been a source of controversy due to differing definitions, interpretations of Keynes, and beliefs about the mechanisms that bring about this equality.

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