Why Save?

• Future Consumption: Savers frequently seek to postpone current consumption expenditures to a later time. People save because they want or need consumption expenditures more at a later time than at the present. Common reasons to postpone expenditures include plans to pay for education, retirement, and relatively expensive purchases (such as houses, cars, and vacations). Purchasing legal claims that can be redeemed at a later time allows people to store the purchasing power of their current income.

  For example, suppose Professor Grumpinkston determines that he needs $50,000 a year to maintain a desired consumption level into his golden retirement years--after he no longer generates income from selling labor resources as an economics professor. As such, he might save or divert a little bit of the income he currently generates from working into the financial markets by buying legal claims (corporate stocks, savings bonds, bank accounts). Upon retirement, he can then sell these legal claims and retrieve the income needed to purchase the goods that satisfy his consumption habit.

• Interest Return: Those who borrow income (the folks selling legal claims) are generally willing to pay savers (the folks buying legal claims) as an incentive to part with a portion of their current income. Borrowers, especially the business sector, are willing to pay to acquire this income because it can be then used for investment expenditures on profit-generating capital goods. This payment is termed interest and is usually stated in percentage terms as an interest rate. Savers are willing to part with income in return for interest.

  For example, suppose OmniConglomerate, Inc. plans to build a $100 million, state-of-the-art OmniMotors automobile factory. This factory is expected to generate $10 million of profit to OmniConglomerate each year it is operating. Because this capital investment generates a 10 percent annual return, OmniConglomerate is willing to pay up to an annual interest rate of 10 percent to borrow the $100 million needed to purchase the capital. Jonathan McJohnson might loan OmniConglomerate $1,000 this year--to help finance their investment--because they promise to pay him back $1,100 next year. Jonathan gives up $1,000 of current income for the prospect of $1,100 of future purchasing power. His sacrifice lets him purchase an extra $100 of goods and services in the future.

Types of Saving

• Bank Accounts: At the top of the list is bank accounts or other types of financial assets. This category includes bank savings accounts, mutual funds, and corporate stock holdings, among a host of others. Saving directed to financial markets is then used to finance spending by other sectors, especially business sector investment expenditures on capital goods.


• Sock Drawer: An alternative form of saving takes the form of money (paper currency and metal coins) held by the household sector. Most people temporarily have money to buy goods. However, some hold on to money as a means of saving. This money can be placed in a "sock drawer," stuffed in a mattress, buried in a can in the backyard, lost between sofa cushions, or sealed in a home safe. Even though this money is not directed toward financial markets, it is not used for consumption either, which makes it saving.


• Public Saving: Another type of saving is that forced on the household sector by government. This public saving is accomplished through taxes. In this alternative, the government sector collects taxes from the household sector, preventing current income from being used for consumption expenditures. If the government sector directs this tax revenue to the financial markets to fund business investment expenditures on capital goods or if it uses the tax revenue for government purchases of capital goods, then saving results.


• Loan Payments: Saving occurs if the household sector does not use current income for current consumption expenditures. While some of this saving is used to purchase financial assets, which can be redeemed and used to pay for future consumption, some is used to repay financial liabilities, which were created to pay for past consumption. It matters not whether current income is to pay for future consumption or past consumption. It only matters that the income is not used for current consumption. As such, any debt repayment by the household sector for any type of loan--credit card, mortgage, car--is an act of saving.

Saving or Savings

Savings (with the "s") is the accumulation of unspent income, often deposited in a bank account, that is, a savings account. This accumulation might have taken place over a single year, over several years, or over a period of less than a year. The means of accumulating savings (with the "s") is most likely through saving (without the "s"). But the total accumulated savings (with the "s") may very well have resulted from several years of saving (without the "s").

Saving (without the "s") and savings (with the "s") represent two important types of variables--flow and stock. Saving (without the "s") is a flow variable. It is activity that takes place over a period of time. Savings (with the "s") is a stock variable. It is an accumulation that exists at a given point in time. A comparable analogy can be had with a bathtub. The water entering into the bathtub is a flow. The amount of water in the bathtub is a stock.

How about an example or four to illustrate?

• Suppose Duncan Thurly has $100 in his bank savings account. This is $100 of income that he has NOT spent on consumption. But the question is WHEN did he NOT spend this income on consumption. If this $100 has been in his bank account for ten years, then the saving (without the "s") took place ten years ago. No current saving (without the "s") takes place. He has maintained a stock of $100, but there is no flow for the year.


• Moreover, suppose that he actually begins the year with $200 in his savings account, but over the course of the year he has $100 more of consumption expenditures than current income. In this case his saving (without the "s") is actually a negative flow, which reduces his stock of savings (with the "s") by $100.


• Alternatively, suppose that Duncan begins the year with $100 in his savings account, then on January 1st deposits $1,200 into this savings, giving him a balance of $1,300. This is the balance that he maintains throughout the year up to and including December 30th. However, on December 31st he withdraws $1,200 to throw an extravagant New Years Eve party, giving him a new savings balance of $100. Even though his average stock of savings (with the "s") is over $1000 for the year, he has no saving (without the "s") for the year. His current consumption expenditures FOR THE YEAR equals his current income.


• Consider a last possibility. Suppose that Duncan has an outstanding credit card balance resulting from goods that he purchased in previous years. His monthly payments on this credit card are $100. Over the course of the year, he reduces this balance by $1,200. Even though his savings (with the "s") account balance does not change, his saving (without the "s") over the year is $1,200. This $1,200 is the difference between Duncan's income and consumption expenditures for the year.

The Circular Flow

The Circular Flow

A basic representation of the circular flow is displayed to the right. The components of this model are the four macroeconomic sectors--household, business, government and foreign--and the three macroeconomic markets--product, resource, and financial.

The household sector at the far left contains the consuming population of the economy. The business sector at the far right includes all of the producers. The government sector is positioned in the middle of the diagram and the foreign sector is at the very top.

The product markets near the top of the flow direct production from the business sector to the household sector in exchange for payment flowing in the opposite direction. The resource markets at the bottom of the flow direct factor services from the household sector to the business sector in exchange for payment flowing in the opposite direction. The financial markets located just above the resource markets divert saving from the household sector to business and government borrowing.

The circular flow indicates that the income used by the household sector to purchase goods through the product markets is obtained by selling factor services through the resource markets. It also indicates that the revenue used by the business sector to pay for factor services obtained through the resource markets is generated by selling goods through the product markets.

Saving is the flow between the household sector and the financial markets. In particular, saving takes place when the household sector diverts a portion of income to financial markets to purchase legal claims. These legal claims are issued by the business and government sectors to acquire income that they use for investment expenditures and government purchases.

On To Investment

An increase in saving (which entails a reduction of consumption expenditures) enables greater capital investment. A decrease in saving (associated with an increase in consumption expenditures) results in less capital investment.

The consequence of investment in capital goods is economic growth. Economic growth occurs due to an increase in the production capabilities of the economy. More capital means greater production capabilities. Less capital means lesser production capabilities.

Determinants

• Interest Rates: Because interest rates affect both the cost of borrowing for durable goods purchases and the return on saving, higher interest rates reduce consumption expenditures and increase saving. Lower interest rates have the opposite effect.


• Consumer Confidence: If the household sector, as a whole, feels good about the economy, then they are prone to undertake more consumption expenditures, especially for durable goods, such as cars, houses, furniture, and kitchen appliances. This results in a drop in saving. Consumer confidence tends to be high and rising when the economy is prosperous and expanding. Consumers, however, can be a fickle group. A hint of bad times, such as signs of a contraction on the horizon, can cause consumer confidence to fall, which then causes a dip in consumption expenditures and more saving. As the household sector spends more, then saving declines. As it spends less, then saving increases.


• Physical Wealth: This is the material, tangible possessions of the household sector, especially durable goods like cars, furniture, and small kitchen appliances. An increase in physical wealth generally reduces consumption expenditures. If consumers recently purchased a number of durable goods, then they have less need to buy more, with a subsequent decrease in consumption expenditures and an increase in saving. Moreover, they are often faced with the need to repay loans used to finance the purchase of durable goods. Such loan repayments are also saving.


• Financial Wealth: This is the money, stocks, bonds, mutual funds, bank accounts, and other documents that provide a claim to goods, resources, and productive assets. When consumers acquire more financial wealth, they tend to spend more freely, with a subsequent increase in consumption expenditures and corresponding decrease in saving.


• Inflationary Expectations: Expectations of future prices and inflation work much the same for consumption expenditures as buyers' expectations work for market demand. Households seek to buy at the lowest prices possible. If they suspect that prices will rise (that is, they expect rising inflation), then they are inclined to buy more today. As such, consumption expenditures increase and saving decreases.