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Explain the link between saving, investment and economic growth, and consider the factors that influence the amount of saving individuals undertake.

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Introduction

Question: Explain the link between saving, investment and economic growth, and consider the factors that influence the amount of saving individuals undertake. Saving, investment and economic growth. Each of these terms are mentioned in daily news and each of these terms is commonly accepted and well-known; separately. What most people are not aware of; however, are mutual connections between these economic indicators and this is what this paper tries to survey. The first section looks at the theoretical and empirical linkages between saving and investment followed by a section where the economic growth is taken into account. The last section covers and explains major determinants of the amount of saving individuals undertake. In order to achieve a consistent conclusion one has to take it step by step. So, let's start with the first term - saving1. In economics "saving is treated as the foregoing of consumption to accumulate assets" and in analytical terms "everyone is agreed that saving means the excess of income over expenditure on consumption"2. Major savers have always been households and their savings then represent "loanable funds" which offer to lend. People however possess one feature and that is the impatience in consumption causing their preference of consuming now rather than in the future. That is the main reason why these people have to obtain interest, should they postpone their consumption. ...read more.

Middle

is rising. Graphs 6,7 simulate the process of change in saving. Let's assume closed economy producing at full capacity where national product (3000 units) can be either consumed or saved (=invested). At the beginning people are spending 2200 units of their income and the rest representing by 800 units is saved and invested at 5% rate of interest. Now suppose that people change their saving preferences. With reference to Graph 7, decision to save more caused the shift of supply curve on the market for loanable funds to the right. This leads to a decrease in interest rate and compared to the original condition more money is now invested and less is consumed. Graph 6 Original condition Graph 7 Change in saving Source: Jonathan Bradley, presentation Even though the current consumption is now lower than before, the new point B on production possibility frontier offers higher level of expansion of this curve and it means higher level of economic growth. Graph 8 with attached table suggests presumable future development. Graph 8 The effect of initial increase in saving on economic growth Slow economic growth - consumption without initial increase in saving Rapid economic growth - consumption with initial increase in saving Period 0 2200 1780 Period 1 2400 2180 Period 2 2600 2580 Period 3 2800 2980 Source: Jonathan Bradley, presentation In reality however such a straightforward link between saving, investment and economic growth is rather a concept than exact model. ...read more.

Conclusion

and it is the importance of precautionary reasons and expectations towards the future. People simply save for rainy days. They do not receive fix salary or their job is unstable. They can expect tough future for more or less whatever reason. People with children can have also incentive to save for their children.21 Probably the last of major determinants could be found in financial system itself. As Howells points out as a financial system becomes more developed (e.g. through expansion of banking system or developing of new liquid assets) people find it easier to borrow and their saving ratio is falling.22 This is probably the reason why America has lower saving rate compared to world average.23 In conclusion one should call the reader's attention that the subject of linkage between saving, investment and economic growth is much more complex and explaining the issue properly would be matter of survey that go far beyond the scope of this paper. Nonetheless, to summarize we can come to the general conclusion that changes in variables of function s(?) represented by people's willingness to save lead to shifts of the supply side on the market for loanable funds causing changes in real interest rates. Those changes encourage (or discourage) investor's determination to realize their plans and through increase in productivity per worker are the subject of faster economic growth which has another reflexive effect on household's saving. ...read more.

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