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Ba LLB economics notes pdf short notes
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Q. 4. Write short notes on the following :
(a) Saving
(b) Paradox of Thrift
(c) Investment
Ans. (a) Saving
Saving refers to that portion of money income that is not spent on consumption. Factors of production receive money income from the total produce (national income) as a reward for their services. All this money income, however, is not. spent on consumption expenditure. Therefore, money income not spent on consumption is called saving. In other words, saving is the excess of income over consumption expenditure. Symbolically, S = Y- C
where S = saving,
Y = income, and
C = consumption
The total or aggregate volume of saving in an economy consists of (i) Personal saving,
(ii) Gross business saving, and
(iii) Government saving.
(i) Personal Saving. It is equal to the personal disposable income minus the personal consumption expenditure of all the individuals of the community.
(ii) Gross Business Saving. This is the retained income of the business units consisting of depreciation allowances and undistributed profits.
(iii) Government Saving. It consists of net government receipts minus government consumption expenditure.
Keynesian approach to saving is different from that of the classical approach. Keynes made saving a function of income whereas the classical writer treated saving as a function of the rate of interest.
According to classical economists, saving depends upon the rate of interest. The higher the rate of interest, the higher will be the saving, and the lower the rate of interest, the lower will be the saving. In other words S = f(r), where S = Saving, r = rate of interest.
According to Keynes, saving depends upon the level of income. The higher the level of income, the higher will be the volume of saving, and the lower the level of income, the lower will be the volume of saving. According to Keynes, the relationship between saving and interest is not highly significant. He argues that some people may not be able to save Even at a very high rate of interest and some may save even at a low or zero rate of interest. So the principal, determinant of saving, according to Keynes, is the level of income.
Symbolically, S = f (Y),
where S = saving,
Y = Income.
Ans. (b) Paradox of Thrift
The classical economists considered saving a virtue. They were of the opinion that a person accumulates wealth through a thrift or restricting the level of consunıption. They advised people to accumulate a fortune by maximizing earnings and minimizing expenditure on consumption. They extended it to the entire system. It was their firm belief that ‘thrift, which was the most desirable object for individuals, was equally desirable for the community as a whole. J.M. Keynes, however, pointed out that an increase in individual saving does not lead to an increase in community-saving. How does it happen? The attempt to reduce consumption by increasing the saving of an individual will result in less income being passed on to the next person since one person’s expenditure is another person’s income: Thus, the increase in a saving of one person will lead to a decline in the income and hence of såving of another person. So the saving of the community remains the same at the previous level. Keynes goes a step further and argues that if all the individuals in the community decide to save by reducing the consumption, the result will be a calamity for the economy, because, more saving means a reduction in the level of consumption expenditure. The decline in the level of consumption expendituré leads to a deficiency in demand for consumer goods .and services. Consequently, the level of income, output, and employmėnt will fall. With a fall in the level of income, the saving of the community will be less. In other words, an attempt to increase savings will lead to a fall in total savings. This is known as the Paradox of Thrift.
The process can be illustrated as follows: Increase in saving > Fall in consumption expenditure > Fall in aggregate demand schedule > Fall in employment > Fall in output > Fall in income > Fall in saving.
From this paradox, we can derive the conclusion that although individual saving may be a virtue, investment saving may be a virtue, saving by the whole of the community may not always be desirable.
(c) Investment
Investment is an important determinant of the level of income, output, and employment in an economy. Investment in macroeconomic analysis refers to the value of that part of the. aggregate output for any given time period which takes the form of new structures, new capital equipment, and changes in business inventories. The value of this output is measured by the amount of total expenditure incurred on these items.
1. Gross Investment and Net Investment
Investment may be either gross investment ‘or net investment. Gross investment refers to a flow of expenditure over a given time period
on new fixed capital (eg, houses, factories, machinery) or on additions to stocks (eg., raw materials, unsold consumer goods, etc.) If K0 stands for capital stock at the beginning of the period, Kt for capital stock at the end of the period t, and ∆ K for the change in capital stock over period t, then It, the investment, may be defined as
It = ∆Kt, = (K1 – K0)
This is called gross investment. A part of the expenditure may be incurred for the purchase of such machinery, equipment, or materials that are required essentially to maintain the stock of the economy’s capital intact. This type of expenditure is referred to as replacement investment or capital consumption. This may be deducted from gross investment to obtain net investment. Net investment, therefore, refers to that amount of expenditure that is obtained after deducting the replacement investment or capital consumption from the gross investment.
Gross investment = Net investment + Capital consumption or replacement investment
or Net investment = Gross investment – Capital consumption or replacement investment
If the gross investment is only sufficient to maintain capital stock intact, the net investment will be zero. If the gross investment is not even sufficient to cover capital consumption, the net investment will be negative; that is, the actual stock of capital is declining. If gross investment exceeds the replacement investment, the net investment will be positive.
2. Financial Investment and Real Investment
We may also distinguish between financial investment and real investment. Financial investment simply means a transfer of rights from one party to another. While one party has made an investment, the other has made disinvestment. It does not add to the stock of real capital of an economy. The purchase of stocks and shares, debentures, government bonds, and equities is a financial investment. It is referred to as financial investment because it does not involve anything more than a mere transfer of the titles of ownership from one individual to the other and the stock of the economy’s real capital is left unchanged, Real investment, on the other hand, means the creation of additional productive capacity. For example, the establishment of a factory or a workshop is a real investment. This creates additional productive capacity and hence, it is an important activity for the economy as a whole. It is in this sense that Keynes has used the term investment in the national income analysis. In the Keynesian sense, when an individual purchases shares, bonds, or securities of a new company, the financial investment will represent a real investment.
3. Planned and Unplanned Investment
Investment may be divided into two parts: viz., (i) Planned investment or intended investment, and (ii) Unplanned investment or
Ir = Ip + Iu
lp= planned investmentlu= unplanned investment.
lt should be clear from the above equation that the actually realized investment in an economy is not always equal to the planned investment. it is only when the unplanned investment is zero that the actual investment could be equal to the planned investment.
4. Induced and Autonomous Investment
Induced investment is that investment that is undertaken as a result of a change in the level of income or consumption. t depends on profit expectations. Entrepreneurs purchase or produce capital goods When they anticipate a high level of sales of final goods. This anticipation depends upon the level of income and the level of effective demand oi consumers. An increase in the level of income leads to an increase in the level of employment and in the demand for consumer goods. This, in turn, results in an increase in investment. Thus, increased investment increases or decreases with the increase or decrease in the level of income. Hence, induced investment is income-elastic.
Autonomous Investment. It refers to that kind of investment that is not affected by the changes in the level of income or output and is not induced solely by the profit motive. Autonomous investment is not a function of output or income. It is related to technological developments, discovery. of the new resources,.growth of population, etc. On each level of income, autonomous investment remains unaltered. Hence autonomous investment is income inelastic.
5. Private and Public Investment
Another important classification of investment may be into private investment and public investment. Private investment refers to the expenditure incurred by the private entrepreneurs on the purchase of capital goods like plant and machinery, or construction of houses, factories, offices, shops, etc., or merely for inventory building. A large part of the total investment in a mixed economy, including India, is accounted for by the State. This investment takes place in the public sector of the economy and is managed by such public authorities as the Central Government, State Governments, Local Authorities (like the Delhi Development Authority), and Public Corporations (like Bharat Heavy Electricals Ltd), etc.
The motivations for investment in the public and private sector tend to be different, In the private sector, the firms aim to maximize their profits. Hence, the expected profitability is the main. a motive for investment. Private entrepreneurs will invest only if they expect a
satisfactory return on a particular project. n the public sector, on the other hand, profit maximization may not be the only basis for investment; investment decisions may be influenced by political and social factors. In our country, the government has invested in such projects as roads, dams, schools, colleges, hospitals, etc. which provide services for which no prices are charged. t is not. possible to compare revenue with investment costs of these projects.
It is time that the social welfare considerations exert a significant influence on the investment decisions of the públic sector. All the same, the public authorities have, also to choose between different projects calling for public investment. All the desirable projects cannot be undertaken; therefore, it is necessary to come to a decision on the basis of which projects are found most worthwhile. For this purpose, the use is being made of cost-benefit analysis by the publíc authorities. Cost-benefit techniques attempt to assess the social profitability and the – social cost of proposed investments. Social profitability and social benefits refer to those satisfactions enjoyed by the community which is not fully revealed in the revenues earned by an enterprise. For example, it will not be correct to evaluate the benefit realized by the government officials in terms of rent realized from them for the various houses constructed by the government for its staff. Obviously, the social benefit far exceeds the benefit expressed by revenues. Therefore, the decision to invest in houses cannot be passed on revenue considerations, it will have to take account of the other benefits. Similarly, the money costs may not be the real costs of any project to society. Considerations like, ‘smoke from the oil refinery at Mathura may adversely affect the Taj Mahal at Agra,’ considerably weigh-in’ evaluating the real costs of a project in the public sector.
According to J.M. Keynes, induced investment is determined by the marginal efficiency of capital and the market rate of interest. The marginal efficiency of capital, in turn, depends upon the prospective income from the capital asset and the supply price of the capital asset.
Suppose, a business unit proposes to undertake some investment project. It will have to borrow money or will have to supply funds out of its own resources to finance the investment project. In the former case, it will have to logo interest which it could have got by lending out those funds. In any case, interest is the price of the investment. While deciding to make an investment, every investor compares the profit which he expects from the investment with the rate of interest which has to pay on that investment. An investor will decide to invest only if the expected profit exceeds the rate of interest he has to pay. Hence, an investor is guided by the following three factors while making a decision to undertake some new investment project :
(i) the prospective income from the capital asset;
(ii) the supply price of the capital asset; and
(iii) the market rate of interest.
