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Home Determination of National Income Logical Identity of Saving and Investment

 

Logical Identity of Saving and Investment:

 

The classical economists were of the view that saving and investment are always equal. They believed in the existence of a fully employed economy. According to them, whenever their is inequality between saving and investment, it is brought to equality through the rate of interest. J.M. Keynes differs with this classical view. According to him, the equality between saving and investment is brought about not through the mechanism of rate of interest but through the changes in income. He also disagrees with the classical view that when saving and investment are equal, the economy is in full employment equilibrium. According to Keynes, the equality between saving and investment can take place below or above the level of employment. The equality of saving and investment at full employment level is a rare phenomenon.

 

Keynesian View of Saving and Investment Equality:

 

J.M. Keynes has put forward two views of saving and investment equality:

 

(1) Definitional Equality and (2) Functional Equality.

 

(1) Accounting or Definitional Equality:

 

According to J.M. Keynes actual saving and actual Investment are always and necessarily equal at any level of income. He writes in his book 'General Theory':

 

Definition:

 

"Saving and investment are necessarily equal in amount for the community as a whole, being different aspects of the same thing".

 

In order to prove it, he defined saving in the current period as the excess of income over expenditure.

 

Formula For Saving:

 

S = Y - C

 

Here, S stands for current saving, Y for current income and C for current consumption.

 

As regard investment, it is the value of current output of capital goods together with the value of any addition to work in progress or the stock of finished goods. Investment is equal to the output of the community minus consumption.

 

Formula For Investment:

 

I = Y - C

 

Where I stands for investment, Y for income and C for consumption.

 

Keynesian's Equation For Saving and Investment:

 

S = Y - C ................... (i)

 

I = Y - C .................... (ii)

 

Taking, Y - C is common from both equations (i) and (ii). So we have:

 

S = I

 

Saving = Investment

 

(2) Functional Equality:

 

According to the second version of Keynes:

 

Definition:

 

"Saving is equal to investment at the equilibrium level of income".

 

It is brought about by the adjusting mechanism of income compared to the classical view of variations in the rate of interest. Keynes establishes equality between saving and investment by defining income (Y) as equal to current consumption plus current investment.

 

Y = C + I .................. (i)

 

Income (Y) is also equal to consumption plus saving.

 

Y = C + S ................ (ii)

 

From equations (i) and (ii), we have:

 

C + I = C + S

 

C will cancel from both sides of the equation, so:

 

I = S

 

 Investment = Saving

 

The basic idea of explaining equality between saving and investment is that it is brought about by changes in income and not through the mechanism of interest rate.

 

According to the functional equality version when people save more than what the investors think it worthwhile to invest, the demand for consumer and producer goods falls down. When the goods produced are not profitably sold, the entrepreneurs curtail production of goods and the national income falls. If investment is more than saving, the national income rises. The process of changes is income, saving and investment continues till saving and investment are in equilibrium. The saving and investment equality is explained with the help of a schedule and a curve.

 

Schedule For Saving-Investment Equality:

 

($ in crore)

Income Saving Investment Income Movements
200 -30 20 Expansion
400 0 40
600 30 60
800 60 80
1000 90 100
1200 120 120 Equilibrium
1400 150 140 Contraction
1600 180 160
1800 210 180

 

In the above schedule, it is shown that so long investment is higher than saving, income level continues to rise. When income is $1200 crore, saving and investment are equal to $120 crore each. After this equilibrium point, saving exceeds investment. The equilibrium between saving and investment is reached when income contracts and again reaches $1200 crore. Saving and investment equality is now explained with the help of a curve.

 

Diagram/Curve/Figure:

 

 

In figure (31.1), income is measured on X-axis and saving and investment on Y-axis. SS/ is the saving curve and II/ the investment curve. When income is OY/, the investment is greater than saving, l/. When investment is more than saving, then income rises. At point L, saving and investment are equal at the equilibrium level of income OY. At point N, saving is greater than investment. The higher saving will bring a fall in income, till the equilibrium is reached at OY, equilibrium income level.

 

The modem economists make use of functional concepts of saving and investment for emphasizing the behavior of the economy as a whole.

Relevant Articles:

Logical Identity of Saving and Investment
Keynes Theory of Income Determination
Determination of Equilibrium for National Income in a Two Sector Economy
Inflationary and Deflationary Gaps
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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