Determinants Of Propensity To Save

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Determinants Of Propensity TO Save

Since saving is defined as that part of income which is not consumed, we have the following identity:

Income = Consumption + Saving
(Y)    = (C) + (S)

An income earner makes only one decision either regarding consumption or saving, the other components is only a residual. It follows then that determinants of aggregate consumption and aggregate saving are the same.

Theories which explain total consumption also explain total saving. However, some of the important factors which affect propensity to save are discussed briefly below:

Saving and Income

It is a matter of common observation that rich propel save more than poor people, not only in absolute but also in percentage amounts. The very poor are unable to save at all. Instead, they “dissave”, i.e., spend more every year than they earn; the difference being covered by going into derby or using up previously accumulated savings. Thus, income is a prime determinant of saving.

Saving and Interest

In general, it is assumed that people have strong preference for present consumption over future consumption. Therefore, a person will forgo present consumption only if he is paid premium equal to or greater than his marginal rate of time preference, i.e., an amount that will make the utility of a rupee received today equal to or smaller than the utility of the sum he will collect in a year if he lends the rupee. Ordinarily, a higher rate of interest will induce an individual to forgo some present consumption. In favor of future consumption.

Saving and Taxation Policy

Taxes reduce the disposable income of the people and they have also to cut down their consumption expenditure. As a result, the level of compulsory saving increases in an economy.

Determinants of Propensity to Save

•    Income levels
•    Interest rates
•    Provision of social security
•    General price level
•    Distribution of income.

Saving and Social Insurance and Life Insurance

Deductions towards provident fund, insurance premium, etc, from the money income also raise the level of saving.

Saving and the Price Level

The nature of relationship between saving and the price level is rather uncertain in economic theory. On the one hand, real balance effect suggests a positive relationship between saving and the price level. At high price, the value of real balances falls which reduce consumption and increases saving. On the other hand, it is argued that high price are associated with lower interest rates in the course of cheap money policy. When the authorities attempt to peg interest rates at low levels, saving is discouraged.

However, a positive change in the price level is found to have favorable effect on saving. It is possible that people expect prices to rise if there is price rise in the preceding period. This may increase consumption of durables like housing, etc. which is recorded as saving.

Saving and Distribution of Income

Aggregate saving in an economy mat depend, among other things, on the distribution fo income. Since the marginal propensity to save of the rich persons is high, therefore disparities of income, will raise the level of saving in an economy. Equitable distribution of income, on the other hand, lowers the propensity to save.

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