Saving is defined as the excess of income over consumption expenditure. The concept of saving is closely related to the concept of consumption. Saving is the part of income that is not consumed. Generally, as the level of income increase, saving also increases and vice versa.
Saving function or the propensity to save expresses the relationship between saving and the level of income. It is simply the desire of the households to hoard a part of their total disposable income.
Symbolically, the functional relation between saving and income can be defined as S= f(Y).
Y= C + S;
Thus, S= Y-C;
Where, Y= Income; S= Saving; C= Consumption
The equation shows that the remaining amount after the deduction of total expenditure from total income is saving. Thus, saving is that part of income which is not spent on consumption
Relationship between Saving and Income
- A direct relationship exists between saving and income. This means, if income increases, saving also increases but in less proportion in comparison to income.
- When income level is low, saving is negative. In the initial stages when income is low, consumption expenditure is more than in comparison to the level of earning, so there is no saving .i.e. dis-saving.
The table and diagram below clearly explains the relationship between income and saving:
|Income (Y)||Consumption (C)||Saving (S)||APS (S/Y)||MPS (ΔS/ ΔY)|
Table 1 Relationship between Income and Saving
Attributes of Saving Function
Saving function or propensity to save has two major attributes:
- Average Propensity to Save (APS)
- Marginal Propensity to Save (MPS)
Average Propensity to Save (APS)
The average propensity to save is a relationship between total saving and total income in a given period of time. It is the ratio of saving to income that shows the portion of the income that people saved.
Where, S= Saving; Y= Income
For example, when the disposable income is 180, consumption is 170, and saving is 10, we can calculate APS as
APS= 10/180 =0.06 or 6%
This shows that out of total income in a year, 6 % will be saved after spending on consumption. As shown in the table above, we can see that the average propensity in save increases with the increase in income .i.e. APS increased from 0.06 to 0.08 with the increase in income.
APS is a point on the curve S, and it is measured as S1Y1/OY1.
Marginal Propensity to Save (MPS)
The marginal propensity to save or MPS refers to the increase in the proportion of saving as a result of increase in the level of income. It can be defined as the ratio of change in saving to change in income.
Where, ΔS= Change in saving; ΔY= Change in income
For example, when income increased from 180 to 240, savings also changed from 10 to 20. We can then calculate MPS as
MPS= 10/60 =0.17 or 17%
This shows that, when income increased, the proportion of saving also increased. The saving made out of total income is 17%.
In the diagram, BC is the change in income and AB is the consequent change in saving. So, MPS is AB/BC.
Determinants of Saving Function
The determining factors that contribute to the saving function include Desire to save, Power to save, and Facilities to save.
Desire to Save
The desire or the willingness of an individual or household to save is the major driving factor towards saving. The factors that affect the desire of an individual to save are
i. Level of income
Level of income is an important determinant of saving in any economy or country. Higher the level of income for any household or individual, higher the level of saving.
ii. Provisions for the future
The future requirements of money is uncertain. So, in order to have a secured future against any uncertain events, saving up at present helps to have a pool of extra money. Savings can be taken as a precaution for any unforeseen needs in the future.
Ability to Save
In spite of the willingness to save, one cannot save if they do not have the capacity or the ability to save. Saving is only possible if an individual can meet all their consumption expenditures and still save up, then it can be said that they have the ability to save. Ability to save depends on the level of income and consumption expenditure.
The factors that determine the ability to save include
i. Labor Efficiency
The ability or power to save depends on the efficiency of labor. If an economy has an efficient group of people, it increases production efficiency as well. This results in increasing income and thus people can have more money that can be saved, even after meeting the consumption expenditures.
ii. Size of National Income
Higher the national income, greater is the ability to save. Low national income in developing and under-developed countries is the main reason for no saving being made.
iii. Developmental activities
The development of various sectors like trade, industrial areas, agricultural sector, etc. is a source of increased income level, as there will be more inflow of money into the economy.
Facilities to Save
Saving also depends on the facilities availability. This includes:
i. Development of financial institutions
The development and expansion of financial institutions like banks, co-operatives, etc. encourage people to save more with their effective marketing strategies. They also provide attractive interest rates on savings.
ii. Rate of interest
Attractive interest rates encourage people to save more. When the interest rates are high in the market, people save more, and when the rates are low, they withdraw and spend on consumption.
iii. Social security system
The provision of security system such as old age pensions, medical insurance, unemployment allowance, etc. reduces the rate of saving in a country. When there is adequate provision of social security in the society, people feel secured about their future and they spend more of their income on consumption.
iv. Taxation Policy
Progressive taxes reduce saving as taxes increase with the increase in income. People with higher income save less because of the taxes they need to pay. But if the taxes on expenditure are higher then, they are encouraged to spend less and save more.
v. Fiscal policy
The fiscal policy of the government affects the level of saving in a country. If taxes are imposed on necessary commodities, people cannot save more. The reduction of taxes on basic goods leads to an increase in the level of saving. Also, if taxes are high on luxury goods, people are enticed to save more than to purchase luxury goods.