The Saving Function
The relationship between consumption and income
also tells us about the relationship between income
and savings.
There is a close relationship between consumption
and saving. And the consumption and saving
decisions are taken simultaneously.
All income which is not consumed is saved, which
implies that what an individual consume does not save
and what he does not consume must save.
Hence, saving is defined as the excess of income
over consumption expenditure, i.e.
S = (Y – C)
1
Types of Saving:
Individual Saving: Saving by the individuals for their
own personal reasons.
example: people save to meet the unforeseen
emergencies.
Corporate Saving: corporate savings by companies
means ploughing back profits into business and so
reducing the amount of profit distributed to share
holders.
Compulsory Saving: it occurs when the govt.
reduces consumption by deliberately increasing
taxation.
Forced Saving: which occurs in mild inflation
because it will bring bout a reduction in the demand
for consumer goods. 2
Hence, total saving in the economy is the sum of:
(a) Personal Saving: Personal disposable income
minus consumption expenditure of an individual.
(b) Business Saving: the retained income of the
business units consisting of depreciation
allowances and undistributed profits.
(c) Government Saving: Net govt. receipts minus govt.
consumption expenditure.
Different Definitions of Saving:
Keynes has defined saving as the current saving
depends upon the current income. Symbolically,
St = f (Yt),
where, saving in period t depends upon the
income in period t.
3
L. R. Klein defined saving as “the function of income. Saving
function or saving schedule may be defined as the schedule
showing different amounts that are saved at different levels
of income”.
It represents a functional relationship between saving and
income. This can be better understood by a schedule given
below:
Saving Function Schedule
(1) (2) (3) (4) (5)
Income Consumption Saving Average Propensity Marginal
(Y) (C) (S = Y – C) Save Propensity to
(APS = S/Y) Save
(MPS = S/Y)
100 100 0 0/100 = 0% --
150 140 10 10/150 = .07 or 7% 10/50 = .2 or 20%
200 180 20 20/200 = .1 or 10% 10/50 = .2 or 20%
250 220 30 30/250 = .12 or 12% 10/50 = .2 or 20%
4
In the above table, column 3 represents saving
function which is obtained by deducting
consumption (column 2) from income (column 1) at
different levels.
Y Y=C
Consumption & Saving
S2
C
S1
C2
C1 B S
a S3
O -a Y1 Y2 X
D S
Income 5
In the above diagram, the saving is derived from
the consumption curve. The Y = C curve shows that
income is equal to consumption or zero saving at
all points of the line.
CC is the consumption line. At zero income level
there is negative saving equal to OC.
At OY income level, the whole of income is
consumed and nothing is saved.
Take OD equal to OC and join D and Y and
extends it to S.
Thus DYS is the saving curve showing different
amounts of saving at various levels of income.
6
Saving function has two technical attributes, such as:
(a) Average Propensity to Save (APS): the APS
refers to the ratio of total saving to the total income.
Symbolically, APS = S/Y
If at Rs. 200 income, Rs. 20 is saved, then the APS
will be 20/200 = .10 or 10%.
APS at different levels of income is shown in
column 4 of the schedule.
APS is complementary to the APC, because APC +
APS = 1 or APS = 1 – APC.
As, S = Y – C
APS = S/Y or (Y – C)/Y = 1 – C/Y = 1 – APC. APC
7
(b) Marginal Propensity to Save (MPS): the marginal
propensity to save is the complement of the
marginal propensity to consume,
so that MPC + MPS = 1
The MPS is expressed as the small change in the
saving to a small change in income, i.e.
MPS = S/Y
For Example: If income increases from Rs. 200 to
Rs. 250, and saving increases from Rs. 20 to Rs.
30, then
MPS = 10/50 = .2 or 20%
This is shown in the previous table.
8
Derivation of Marginal Propensity to Save:
Since saving is excess of income over consumption and a
change in saving is equal to change in income minus change
in consumption,
The MPS will be equal to one minus marginal
propensity to consume.
Derivation:
S=Y–C
S = Y - C
Since MPS is the ration of change in saving to
change in income.
S/ Y = Y/Y - C/ Y
MPS = 1 - C/Y
MPS = 1 – MPC 9
Paradox of Thrift:
It’s a dilemma whether saving is a virtue or vice????
The classical economist and Keyes differs fundamentally on
the question whether saving is virtue or vice.
The classical economics based on the foundation of Laissez-
faire policy advocated that saving was great private virtue.
When an individual increases his saving, it amounts to
maximizing his welfare, which again leads higher individual
saving will boost higher aggregate saving of the community.
According to them, when individual saves, he accumulates a
fortune by maximizing earning and minimizing expenditure on
consumption.
More savings leads to more investment, and more
investment leads to more income.
Since increased savings by all individuals mean increased
savings of the community as a whole, saving is beneficial to
the society. 10
However, this view was severely criticized by the
underconsumption theorist and said that this
view contradicts concept of one man’s
expenditure is others income.
They held the view that an increase in the
aggregate saving would reduce consumption in
the community.
This in turn, would reduce effective demand,
output, national income and employment.
They believed that there was no virtue involved
in the accumulation of saving.
11
On the other hand, Keynes in his general theory of
employment states that the virtue of saving depends on it
use.
If saving is invested, it will boost production, national income
and employment.
In this event, saving would be of social use and therefore,
can not be considered as a vice.
If, on the other hand, saving is not invested but merely
hoarded, it reduces the aggregate demand, employment
and output.
Thus, saving become a public vice. He Pointed out that one
man’s expenditure is another man’s income in the economic
system.
Hence, when the aggregate saving increases in the
community, it reduces the aggregate demand for consumer
goods. This in turn, adversely affects the demand for capital
goods.
As a result, there will be over all reduction in demand,
employment, income and output. Thus saving becomes
harmful to the society and ceases to be a virtue. 12
