Consumption and Investment Consumption, saving and investment play a central role in a nations economic performance.

Americas economic boom of the late 1990s was largely fueled by rapid economic growth in consumer spending . When consumption falls because of higher taxes or loss of consumer confidence, as happened in Japan in the 1990s this reduce total spending and causes recision.

The following relationship shows how consumption and Investment effects the whole structre of the economy . Consumption and Investment Aggregate Demand Investment and Capital Aggregate Supply

Interaction of AS and AD

Consumption is the largest single component of GDP, constituting 66 percent of total spending over the last decade. Consumption Durable Goods: Motor vehicles and parts, Furniture and house hold equipments, other. Nondurable Goods: Food, Clothing and Shoes, Energy Goods, Other Services: Housing, Household Operation, Transportation, Medical Care, Recreation, Other.

Income, Consumption and Saving are closely linked . Personal saving is that part of disposable income which is not consumed. Saving equals incomes minus consumption. Income is the primary determinant of consumption and saving. Rich people save more than poor people, both absolutely and as a percentage of income.

(1) Disposable Income ($) Consumption

(2) Net Saving (+) Dissaving ($) (-)

(3)

($)

________________________________________________________________ A B C D E F G 24,000 25,000 26,000 27,000 28,000 29,000 30,000 -200 0 200 400 600 800 1,000 24,200 25,000 25,800 26,600 27,400 28,200 29,000

To understand how consumption effects national output, we need to understand how many extra dollars of consumption and savings are induced by each extra dollar of income. This relationship is shown by Consumption function relating consumption and Income. Its twin saving function, relating saving and income. The Consumption Function: One of the most important relationships in all macro economics is the consumption function. The consumption function shows the relationship between the level of consumption expenditures and the level of disposable personal income. This concept introduced by Keynes. Draw the consumption function diagram

The relationship between income and consumption is shown in figure-1, is called consumption function. The 45 degree line tells us immediately whether consumption spending is equal to greater than or less than the level of disposable income.

The breakeven point on the consumption schedule that intersects the 45 degree line represents the level of disposable income at which household just break even. This breakeven point is at B in Figure. Here consumption expenditure is equal to disposable income: the hosehold is neither a borrower nor a saver. At an income of $28,000 the level of consumption is $27,000. We can see that consumption is less than income by the fact that the consumption function lies below the 45 degree line at point E. Net saving is measured by the vertical distance from the consumption function up to the 45 degree line, as shown by the EE saving arrow. The 45 degree line tells us that to the left of point B the household is spending more than its income. The excess of consumption is over income is dissaving and is measured by the vertical distance between consumption function and the 45 degree line. Saving Function: The saving function shows the relationship between the level of saving and income. This saving function comes directly from fig -1. It is the vertical distance between the 45 degree line and the consumption function. For example at point A in figure 1 we see that households saving is negative because the consumption function lies above the 45 degree line. Figure 2 shows this dissaving directly directly- the saving function is below the zero saving line at point A. Similarly positive saving occurs to the right of point of B because the saving function is above the zerosaving line. Draw the saving function diagram

(1) (5) Disposable

(2) Consumption

(3) MPC

(4) Net Saving MPS

Income ($) A 0.20 24,000

Expenditure ($) 24,200 25,000 25,800 26,600 27,400 28,200 29,000 800/1000 = 0.80 800/1000 = 0.80 800/100 = 0.80 800/1000 = 0.80 800/1000 = 0.80 8000/1000 = 0.80

(4) = (1) (2) ($) -200 0 200 400 600 800 200/1000 = 200/1000 200/1000 = 200/1000 = 200/1000 = 200/1000 = 200/1000 = 0.20

B 25,000 =0.20 C 0.20 D 0.20 E 0.20 F 0.20 G 26,000 27,000 28,000 29,000 30,000

1000

Marginal Propensity to Consume: Marginal propensity to consume is the extra amount the people consume when they receive an extra dollar of disposable income. MPC + MPS = 1. Investment Investment means addition to the stock of producers assets or capital goods. There is investment only when real capital is produced. The second major component of private spending is investment. Investment plays two roles in macro economics First as it is large and volatile component of spending, investment often leads to capital accumulation Investment increases national output and promotes economic growth in the longrun. Thus investmetn plays a dual role , affecting short run output through its impact on aggregate demand and influencing longrun output growth through the impact of capital accumulation. MPS = 1- MPC.

Investment represents gross private investment or I. It is the domestic component of total social investment which also includes foreign investment, Govt. investment, and intangible investments in human capital and improved knowledge. Many people speak of investing when buying a piece of land, an old security, or any property. In economics these purchases are financial transactions or financial investments. Why do business invest? Business buy capital goods when they expect that this will bring profit to them i.e. will bring revenues greater than the costs of the investment . Thus three things are essential to understand investment: revenues, costs and expectations. An investment will bring the firm additional revenue if it helps the firm sell more products. Second important determinant of the level of investment is the cost of investing. For durable goods cost of capital includes not only the price of the capital goods but also the interest (cost of borrowing) that borrowers pay to finance the capital as well as the taxes (tax on corporate profit) that firm pay on their incomes. The third element in the determination of investment is profit expectation and business confidence. Investment is a gamble on the future , a bet that revenue from the investment will exceed the cost.

1 2 3 4 5 Projec Total Annual Cost Annual t Inv.in Revenu per Net Project e $ Profit $1,000 1,000 per Investe of $1,000 d projec Invested t (5) = (3)

A B C D E F G H
Unemployment

1 4 10 10 5 15 10 20

1500 220 160 130 110 90 60 40

100 100 100 100 100 100 100 100

- (4) 1400 120 60 30 10 -10 -40 -60

Meaning: It is a state of affairs when in a country there are large no. of ablebodied persons of working age who are willing to work but cant find work at the current wage levels. Types: There are three main types of unemployment. (1) Frictional Unemployment - Some time required for searching jobs who have voluntarily left jobs and unemployment prevail in the economy. They are between jobs. They are not able to get jobs because frictions such as lack of market information about jobs, lack of mobility. Some time is required for job searchers to get the information. (2) Structural Unemployment- It exists in a growing economy. It refers to the mismatch between unemployed persons and the demand for specific types of workers. This occurs due to change in structure (composition) of demand for the industrial products or due to change in the technology. The distinguishing feature of this unemployment is that workers lack skills required by the expanding industries. Computerization in Banks.

Structural unemployment lasts longer than frictional unemployment as more time require to take new training or acquire new skills or move to new locations. It is more dangerous than frictional unemployment as people are likely to get jobs within a short time as jobs exists incase of frictional unemployment. For structural unemployed no scope to get job as training requires much time. They can be expected to get low paying unskilled jobs. Natural Unemployment: It may be mentioned that frictional and structural unemployment together constitute what is called natural unemployment.

Cyclical Unemployment: It occurs due to deficiency in effective demand. This occurs during depression or recession and capitalists countries mostly face this. Recession is a phase of business cycle. Private Enterprise Economy. Full Employment: It may be defined as the situation wherein all those who are willing and able to work at existing wage rate are in fact employed for the work in which they were trained. Two things are to be noted- first full employment does not mean every one is employed. People like children, old men, and physically or mentally handicapped are not able to work. No question of their being employed. They are not included in labour force. Full employment will exists in spite of their not working. Some people are called idle rich though are able to work are not willing to work. The get sufficient unearned income.

It is clear that unemployed people are those who are involuntarily idle. They are willing and able to work but economy does not provide them jobs. Full employment is said to exist in the economy even if there is prevailing some amount of frictional and structural unemployment in the economy. If no. of unemployed is greater than frictional and structural unemployment than only full employment does not prevail. Developing Countries: Nature and Causes of Unemployment(1)Lack of Adequate Capital.

(2) Lack of Wage good (consumer goods). (3) Lack of stock of physical capital. (4) Use of Capital Intensive technique. (5) Inequitable distribution of land (Agriculture). (6) Rigid Protective labour Legislation (No retrenchment). (7) Neglect the role of Agriculture in Employment. (8) Lack of Infrastructure. Disguised Unemployment: It manifests in idleness, that is time not worked. It appears in the form of reduction in hours worked in a day, or days in a week or month in a year. To tal output increases at a diminishing rate. When size of the family increases, due to rapid growth of population and when alternative employment beyond families not available, the additional members to be absorbed in family farms. Since on the family farms a point reached beyond which no increase in labour inputs leads to the rise in total output. As a result no. of working hours performed by all workers in a day, or week in a month or year is reduced.