2.2 SAVINGS
This video is relevant for this section despite it saying that it is for AQA.
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What determines savings?
Households receive income from the factors of production which they provide to firms. With this income they choose how to use it. They can either consume all of their income, save all of their income or a bit of both. Income is a flow and wealth is a stock. If you choose to save some of your income then you add to your wealth. Savings is disposable income which is not spent. From an individual’s income we can work out their saving ratio, which is the percentage of someone’s disposable income that they save. A low savings ratio means that there is a higher level of consumption and aggregate demand. But what influences individuals decisions when deciding how much to save?
Households receive income from the factors of production which they provide to firms. With this income they choose how to use it. They can either consume all of their income, save all of their income or a bit of both. Income is a flow and wealth is a stock. If you choose to save some of your income then you add to your wealth. Savings is disposable income which is not spent. From an individual’s income we can work out their saving ratio, which is the percentage of someone’s disposable income that they save. A low savings ratio means that there is a higher level of consumption and aggregate demand. But what influences individuals decisions when deciding how much to save?
- Real interest rate – the real interest rate is the nominal interest minus inflation. An interest rate is the return that you receive on you savings. Savings is income that the user is keeping for future consumption. By saving some income now, you can consume a greater amount of goods in the future. Therefore, the higher the real interest rate is, the greater incentive there is to save as you will you get a greater payoff in interest, meaning that future consumption is relatively cheap compared to current consumption. A lower real interest rate reduces the incentive to save as the payoff from saving is less.
- Expectations. Expectations are crucial in economics. If individuals believe that they are in a stable job and the economy is in a good position then they are less likely to save and instead consume as consumer confidence is high. Suppose now that the economy is in a deep recession and many workers are losing their jobs, it is likely that individuals will save more because they are worried about what the future may bring.
- Tax schemes – in the UK we have ISA’s which enable individuals to place around £15,000 per year, which is the government providing an incentive for individuals to save.
Dissaving/ Borrowing
As well as savings we need to look at dissaving or borrowing. Borrowing is influenced by many different factors such as:
As well as savings we need to look at dissaving or borrowing. Borrowing is influenced by many different factors such as:
- The real interest rate. Again the real interest rate has an effect. The higher the real interest rate is the more expensive borrowing becomes. If borrowing is more expensive, then it is less likely that individuals will choose to borrow and the opposite will be the case if borrowing is cheaper through a fall in the real interest rate.
- Availability of credit – if credit is readily available then individuals and firms are more likely to take on debt. During the financial crisis of 07/08, individuals found it harder to borrow from financial institutions, as financial institutions were less willing to lend out. Also, banks were more picky about who they would grant mortgages to and they also required a larger deposit when taking out a mortgage.
Why is the Level of Savings Important in an Economy?
The saving levels in an economy have a powerful effect on economic performance for various reasons, such as:
The saving levels in an economy have a powerful effect on economic performance for various reasons, such as:
- Savings from individuals flow into financial institutions that are then able to lend the money to small businesses that can use their new funds to invest and grow. Also, a lot of pension fund capital goes into the stock market which allows larger companies to expand their production and grow. If savings levels are high in an economy, and providing that the investment is used wisely, then the productive potential of the economy can increase and the economy will grow. Keynesian economics regard savings as a positive in the economy.
- Savings add to the stock of wealth of an individual, which acts as a buffer against uncertain times. This allows consumers to have a smooth level of consumption over the favourable and tough times. Also, if individuals have a stock of wealth they can retire early or have a higher standard of living during retirement.