Income and Savings Reduce As People Increase the Saving Habit Essay

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Savings and Income Decline as People Increase the Saving Habit

Saving refers to the income not spent by the consumer. In other words, savings are the money left when the consumer expenditures are subtracted from the disposable incomes that an individual earns over a given period. (Credo, 2006). When analyzing private and public savings, the savings refer to the sum of the public and private saving. (Credo, 2015). While private saving (S) is the amount of money not spent by consumers, the public saving is the overall taxes minus the government spending. However, as people attempt to increase their saving ability, the results are a decline of aggregate demand leading to a decline in savings, income, aggregate production and growth rate. (Ronald, 2015).

Objective of this paper is to investigate the reason aggregate savings and income decline as people attempt to increase their savings

Model

The paper uses paradox of saving the model to investigate the reasons aggregate savings and income decline as people increase savings. (Keynes, 1936). Using the paradox of saving the model, it is revealed that as people attempt to increase savings, the results lead to a fall in economic growth. The paradox of saving is an economic theory revealing that the more people save the less they stimulate the economy. An economist Maynard Keynes develops the paradox of saving by using following equation to explain the model: (Keynes, 2003).

Suppose given a level of income, consumers decide to increase their savings leading to a reduction in c0 assuming that c1 remains unchanged. The output and savings will be as follows:

Given C = c0 + c1YD

S = --c0 + (1 --c1) YD

As being revealed in the graphical illustration below

The Output (Y) will drop as being revealed in the following equilibrium:

Y=1/1-c1 [c0 + ? +G --c1T]

Moreover, the private saving (S) will remain unchanged because:

-- c0 is higher,

YD is lower, which is (1 --c1) YD is lower.

In the market equilibrium,

Using the good market equilibrium:

"I = S + (T -- G) and I ?"

Thus, Increase --c0 = drop (1 --c1) YD

Discussion of Results

The logic behind Keynes model is that as people save money, the results lead to a reduction in aggregate consumption, aggregate demand will fall, which will impede an economic growth thereby lowering the overall savings. In other words, as marginal propensity to save increases, firms will record a decline in demand leading to a fall in revenue thereby impeding further saving and economic growth. (Floden, 2008, Hartry, 2008).).

This paper explains the reason the aggregate saving decline as people attempts to save more using the monetary example. Suppose everybody in the country earn $1,000 as income, and they save 50% ($500) from their income, and spend the rest 50% ($500) that supports a demand for products, which in turn create job opportunities, encourage businesses to produce more goods, and generate revenue through tax for the government. However, if everybody in the country decides to save for the retirement, and spend $250 and save the rest $750. The increase in saving will decline aggregate payment of goods and services leading to a drop in demand for the goods and services in the economy. Moreover, businesses will record a drop in profits, and some of them will lay off workers that will consequently raise unemployment level, and overall results will lead to a decline in tax and public revenue for the government. (Hartry, 2010). Moreover, the unemployed people will stop spending altogether because they do not have access to a disposable income, and the issue will worsen the economic situation resulting in a downward spiral of the economic problem. (Gans, 2009). While saving maysaving may be good for people, however, an increase in the aggregate saving can harm the economy because some level of spending through consumption is essential to maintain a healthy economy to ensure that business generates employment opportunities for people, and provide revenue through tax for the government. (Hartry, 2002).

Ironically, as people save less, the issue is likely to lead to a recession causing a falling income and a decline in national saving. Although, the paradox of saving record a diminished attention in the last few years because Federal Reserve claimed to developdeveloping a strategy to engineer the U.S. economic stability. However, the theory gained a renewed international attention after the U.S. financial crisis revealing the limitations of the Federal Reserve economic strategy.

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(The Economist., 2009).

Critical appraisal

Despite the elegant argument of the Keynes theoretical framework, some critics still believe saving is likely to increase investment in the economy. For example, saving is similar to investing in companies because when banks offer loans to companies from the funds saved in the banks, the results will lead to a capital investment. Thus, saving assists firms to engage in investing activities based on the loans raised from the banks. Some critics even dispute that when people save, banks will have a more disposable fund to offer loans to firms for investing activities. (Samuelson, & Nordhaus, 2005). It is critical to understand that the assumption of the Keynes model is that there is a close economy without international trade. However, a rapid development of information technology has made the impact of Keynes model on the entire economy to decline gradually. In the contemporary business environment, businesses are taking the advantages of globalization and internet technology to seek markets outside their home countries. If a propensity to save is high in their home countries, a business can easily take the advantages of internet technology to tap markets in another geographical locations. It is essential to realize that Keynes developed the model in 1936 when the international trade was at very minimal, and internet technology was unknown. Even after the Second World War when businesses have increased the cross-border investments, the Keynes model still holds globally because it requires a significant investment to establish in another countryies. Thus, little percentages of American businesses invest globally. The effect of the Keynes model on the aggregate economy has started to decline after the 1990s based on the introduction of internet technology and rapid development of information technology.

However, this paper still argues that the impact of Keynes model is still high in many countries. Apart from the American, Canadian, Australian and European companies that have taken advantages of IT tools to launch their products globally, many countries have not yet taken the advantages of the internet technology to search for market internationally.

Real World Examples

Chamley, (2012) uses the U.S. economy data to demonstrate the support for the Keynes model. The author argued that the U.S. recorded a decline in the personal saving from 10% in the 1970s to 2% in 2006. During thisese period, the U.S. economy recorded a boom because the aggregate demand increased leading to an increase in the economic growth. However, the savings rate were reversed since 2008, and savings has increased by more than 5%. During these years, the country GDP (gross domestic product) collapsed. These examples have reminded people that savings and investment go "pari-passu," and are a central macroeconomic issue. Typically, fall in consumption has made large business organizations to accumulate a large amount of liquid asset without embarking on investment showing that the country saves too much.

Chamley, (2012) argues that the Keynes model shows that a reduction in aggregate consumption is "a shift of consumer's preference towards the future" (Chamley, 2012 p 1217). Thus, the increase in saving is at the expenses of aggregate consumption. With the increase in saving, people are consuming less of current production. It is essential to realize that GDP (gross domestic product) measures the entire aggregate output in the economy. For example, the EU GDP is valued Euro11, 634 Billion in 2010. (See table 1). However, the consumption (C) alone is 57% made up of Euro 6, 735 Billion. If there is a sudden decline in saving, there will be a sudden decline in consumption, and the results will lead to a decline in the EU GDP that will consequently lead to a further decline in the investment opportunities in Europe.

Table1: EU GDP in 2010

Billion Euro

% of GDP

GDP (Y)

11,634

1

Consumption (C )

6,375

57.9

2

Investment (I)

1,892

16.3

3

Government Spending (G)

2,566

22.1

4

Net exports

1.1

Exports (X)

4,890

42

Imports

-4,754

-40.9

5

Inventory

60

0.5

Conclusion

The papers investigates the reasons savings and income decline as people attempts to increase their saving habits. The paper uses the Keynes model to provide the answers, and based on the results of the investigation it is revealed that savings decline consumption which consequently reduces further production of goods and services. The overall effect is a decline.....

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