INTRODUCTION
The level of income and savings
drawn from current income has generated much interest among economist and
policy makers since 1936. the limiting factor theory and the vicious cycle
theory of underdevelopment explain that countries like Cameron, babon, chard,
Nigeria, Latin America sudden and many more are poor because their real incomes
are cons as such a large percentage of these real income is directed towards consumption
rather than towards production. High consumption means low savings, low
investment and low capital formation and low capital formation translates to
low productivity hence low real income and the process continues.
Consumption and savings one two of
the key of macroeconomics aggregate in economy. They are crucial in determining
an economics equilibrium level of employment and aggregate income hence they
are determining variables
Consumption is simply defined as the
value of goods and services bought by people and individual buying acts are
aggregated over time and space.
According to Anyanwu (1995)
consumption is the total demand for all consumer goods and services to satisfy
human wants. Frank and Bernake (2001) defined consumption as the spending by households
on goods and services such as clothing, food items, entertainment, health
services and acquisition of assets among others.
Paragraphs
rising from this definition is the concept of consumption function which shows
the relationship between consumption and disposable income. Consumption is referred
to households expenditure on goods and services which yield utility in the
current period of final goods and services.
This definition effectively excludes
expenditure on goods and services that were produced in a previous accounting
period.
Consumption expenditures constitutes
a key component of aggregate expenditure used in national income determination
which in its broadest form can be written for an open economy as: y = (c + 1 + s
+ x – m) in Keynesian economic analysis, savings represents the difference between
income and consumption. The reason is that income is either consumed or saved.
Thus saving is defined as the amount
of income per time period that is not consumed by economic units. For the
household it represents that part of disposable income not spent on
domestically produced or imported consumption of goods and services. For the
firm, it represents undistributed business profits. In all savings is a flow
variable, being measured overtime.
CONCEPT
OF CONSUMPTION AND SAVINGS
An understanding of the meaning and behaviour of various concepts of
consumption and savings are necessary. These concepts include marginal
propensity to consume average propensity to consume as well as marginal and
average propensity to save.
MARCINAL
PROPENSITY TO CONSUME (MPC)
The MPC refers to the fraction of additional disposable income that is
consumed.
Keynes economic analysis assert that
“men are disposed as a rule and on the average, to but not by as much as the
increase in their income. In summary therefore, the marginal propensity to
consume is the ratio of change in consumption to the charge in income which is
symbolically represented thus MPC = ∆ c/∆y
MARGINAL
PROPENITY TO SAVE (MPS)
Since what is not consumed is by definition saved, the marginal propensity
to save can be the ratio of change in savings to the charge in income
(disposable or national) symbolically, it can be written thus MPS = ∆ S/∆y
L like
the MPC, the value of MPS is greater than zero but less than one. Greater than
of their additional income but less than one because they will not increase
their consumption by as much as the increase in their income,
Thus MPC + MPS = 1
The
foregoing analysis shows that both MPE and MPS are in the same term as the rate
of change of consumption (savings) with respect to disposable or national
income.
AVERAGE
PROPENSITY TO CONSUME (A P C)
This refers to the fraction of total
income that is spent on consumption. Being the ratio of total consumption
expenditure by total income.
Symbolically APC is expressed as C/Y
AVERAGE
PROPENSITY TO SAVE (APS)
APS
is that proportion of income that is devoted to savings. Since it is the
fraction of income that is saving to the income (disposable, national)
THEORIES
/HYPOTHESES OF CONSUMPTION
There are number of theories purporting to explain the behavior of
consumption in both the short and long run. These existing theories include
i. Astute income Hypothesis
ii. Relative income Hypothesis
iii. Permanent income Hypothesis and
iv life cycle Hypothesis of consumption
ABSOLUTE
INCOME HYPOTHESIS (A/H)
The A/H is the oldest theory of consumption and and was a fall out of
Keynes “psychological law” ITS emphasis was that an individual’s consumption
decision was based upon the absolute level of his current income.
FEATURE OF ABSOLUTE INCOME
HYPOTHESIS
(1) Consumption
and saving are functionally and directly related functions of disposable
income.
The
relationship is a stable one.
(2) They
can exhibit non linear relationships. In this case we will find that the MPC
falls as income rise and MPS rises as income rises.
(3) The APC falls with increase in income but
it is greater than MPC. This feature exists at an intercept term in the
consumption function.
This
means that at very low income levels consumption spending could actually out
ship income
Consumption function here can be
examined thus
C= a + by d
From
this relationship our MPC is dc/dyd cd
APC
is (a + byd
Problems
of AIH
The
AIH was as subjected to empirical verification by kunzites. The AIH assertion
that the APC would decline with increases in income as well as its assertion of
a stable consumption function over the business evidence. The AIH exhibited
consistency when tested with data collected from a sample of household and
classifying them according to their income groups. Moreover, it was consistent
with empirical evidence obtained from annual data of real income and
consumption for the economy as a whole (short-run time-series data) However, it
was inconsistent with the empirical evidence obtained when it was tested using trend
values of consumption and income collected over a long period of time.
Long-runtime-series data are characterized by a smoothening out of cyclical fluctuation
in time-series overtime.
Test
the AIH with this type of data showed on APC that exhibited constancy with no
tendency to rise or fall as income fell or rose. From mathematical view point
the explanation of the failure of is found in the existence of the intercept
term. APC equal MPC with a zero autonomous consumption function, because both
APC and MPC will be equal in the absence of the intercept term, both will
exhibit constancy dor all levels of incomer, Research effort were however
directed at resolving the first problem of an unstable long in APC, First the
observed long in constancy was a denial of Alvin hypothesized the possibility
of an increasing to result in the economy being surfeited with capital good In
the long nun bringing about an inadequate” investment outlet to channel the
extra sarongs back in the spending
stream” what was left was for researchers to establish the invalidity of the
hypothesis following the empirical result form the AIH.
The
second was that of trying to reconcile the conflate that was apparent in the
different sets of statistreal result. The efforts that were made in this regard
resulted in the formulation of other consumption hypotheses. These theories
included the Relative income hypothesis, the permanent income Hypothesis and
the life cycle Hypothesis. These hypotheses in addition to trying to reconcile
the conflict that emerged from testing the AIH using different set of
statistical data also tried to overcome a second defect in the AIH. That defect
was its failure to incorporate the role of wealt and interest rate as we find
in the micro economic analysis of consumption behavior in the explanation of
consumption.
RELATIVE
INCOME HYPOTHESIS (RIH)
The RIH was development James Queensberry in 1979.
This theory was based on idea that were not considered in earlier economic
analysis these are
(1) That consumption behaviour of individuals
was influenced by consumption behaviour of other individuals.
(2) That the consumption behaviour of
individuals exhibits a “ratchet effect” deriving from the fact the consumption
behaviour tends to be habitual:
This habitual nature shows that people try to maintain
the fact that they may have experienced a decline in income not with-standing.
Dusenberry
posited that an individual’s consumption and saving decision are influence by
social environment. Thus, given a level of income, an individual is likely to
consume more of that income if he lives in environment dominated by the
well-to-do in society than if he lives in less affluent neighborhood. Moreover
efforts by the individual to maintain a certain economic status in his
neighborhood means that he spend more out of his income to maintain that
status. Thus, his consumption, rather than being related to his absolute level
of income would be related to his relative income within his neighbourhood.
This makes for a constant average propensity to consume given a relatively
constant income distribution. Moreover, it makes for a proportional
relationship between aggregate consumption and aggregate disposable income.
GRAPHICAL
ILSLUSTRATION
The graph below illustrates Dusenberry’s explanation
of proportional/ no proportional relationship of consumption and disposable
income.
THE PERMANENT INCOME
HYPOTHESIS (PIH)
The PIH as proponded by Milton
Friedman attempt to explain the proportional/non proportional relationship
between consumption and disposable income. Its basic premise is that
consumption decisions are not based solely on the current level of disposable income
but on past and expected future income as well.
Friedman also thought of consumption
as being decomposable into two viz permanent and transitory consumption. Hence
we can write C = Cp + C transitory consumption were (i) It was uncorrelated with permanent income and more controversially,
it was uncorrelated with transitory income.
The CMX of the PIH then was that
permanent income YP determines permanent consumption cp. So cp is proportional
to yp this relationship can be stated as cp = kyp where k is the factor of
proportionality. It is constant equals the MPC and APC. The proportionality relationship
specified above implies therefore that households consume about the same
proportion of their permanent income and this relationship is expected to hold the
distribution of permanent income notwithstanding.
Because permanent consumption and
permanent income are long run trend values of consumption and income the
hypothesis is consistent with long run time sense data which suggests that APC
is constant. In conclusion the theory proposes the proportional nature of the
basic long run relationship while predicting a short run non proportional relationship
for cross section data.
POLCY
IMPLICATION OF PIH
One unless implication of the PIH is that unless consumers perceive the
increase in their income as permanent rather than transitory, any change an appreciable
impact on their consumption behaviour appreciable impact on their consumption
behaviour. The implication of this for policy designed to affect disposable
income in far reaching it means that consumer’s failure to adjust their
expenditure in response to a change in disposable income brought about by a
fiscal policy action desyned to affect output and employment will hardly be expected
to exert the desired impact if consumers as the charge in disposable income as
transitory.
The
major defect of the PIH is elusive nature of the key variables in the
hypothesis. These variables are permanent income and consumption. Being elusive
these key concepts are difficult to isolate and utilize for statistical testing
of the hypothesis. Past experiences and expectation brings about determines a
household permanent income, yet this can change overtime. Thus while it is
difficult to obtain a measure of permanent income at the micro economics level,
the difficulty is by no means lees when wered from the macroeconomic level.
THE
LIFE CYCLE HYPOTHESIS (LCH)
Economic unit should base their consumption decision on expected life
time income instead of current income. The LCH considers the possibility of
consumer unity’s saving in “fat years to smooth out consumption in “lean years”
the L C H posits that individuals wish to spread life time income such that
they would enjoy a pattern of consumption that is optimal over their years lab
our income is usually higher tow ever it drops to zero on retirement and any
consumption after retirement will be financed from accumulated after wealth the
graph below can be used to explain the foregoing Issues in the LCH.
The
diagram deputes the par tem exhibited by income earnings and consumption in the
life cycle of the individual. Low in early years of his working life. Rising in
the middle of his career and again low at retirement. The central preposition
of the LCH is that it is rational for the individual to borrow in the early
years of his working life to finance his
consumption needs repay the borrowed funds in the middle of his carrier when
his income with in this phase of his working life and use the saving to finance
consumption on retirement.
DEPECTS
OF THE LCH
Like
the PHI the LCH cannot be subjected to the rigors of empirical testing because
of the unobservable nature of one its key explanatory vandal’s v12, the
expected lab our income. John muellbaeur argued that“the inability to observe
life cycle income has protected the hypothesis form serious testing and the
possibility of rejection.
CONSUMPTION:
is an important single component of aggregate expenditure firms produce goods
and service become they are demanded. It is appropriate to say therefore that
it is the level of aggregate expenditure that influences indirectly the level
of aggregate income hence has direct influence on production. Therefore we
examine the factors that determine these aggregate expenditure relationships
J.M Keynes had asserted that the determinants be group into two: Objective and
subjective factor
OBJECTIVE
FACTORS
This
are specific and quail gable factors that determine how much of their
disposable income people are willing to spend on consumption among these
factors are
1. The level of income: the principal
factor affecting an individual’s consumption expenditure is his level of
income. It is a vital determinant of the proportion of disposable income that
goes into consumption spending
2. Income
distribution: the distribution of income in the economy has an influence
consumption expenditure too. It is usual that people in the higher income
brackets have a lower tendency (propensity) to consume out of a lower tendency
those in the low income bracket having met their basic needs tend to spend less
on such needs as compared to those who are in the low income bracket that are
yet to meet these needs. Since the income distribution is in the favors those
in tighter income bracket and vice versa.
3. Price
level ==> this determinant of consumption expenditure is in conformity with
the ordinary law of demand. The influence of price level on consumption is an
inverse one with price increase reducing consumer’s purchasing goods and
services but increasing same with a fall in the price level.
4. Availability
of credit: it is an important determinant of consumption expenditure in that
credit availability makes it possible for the consumer to temporarily make
purchase in excess of that he can make given his income or cash holdings alone.
Because credit availability enlarges the consumers scope to purchase goods and
services. Credit availability positively influence the level of consumption
expenditure in the economy.
5. Cost of credit (Interest Rate): Closely
related to credit availability as determinant of consumption expenditure is the
cost of credit, usually proxied by the interest rate. Consumers generally pay a
price by way of interest payment on the credit facilities enjoyed by them.
6.Fiscal Policy: Taxation one of the key
weapons of fiscal policy influencing consumption expenditure via its effect on
consumers disposable income. Tax increases reduces consumers’ disposable income
and therefore their consumption expenditure and vice versa. Moreover,
government expenditure, another key fiscal policy too influences consumption
expenditure positively. Increased government expenditure by way of transfer
payments and other unemployment benefits serves to increase consumption
expenditure vice versa.
7. Depreciation
Allowance: Higher depreciation allowance (amount set aside for tear and
wear durables) translates to higher level of consumption expenditure vice
versa.
8. Stock
of Durable Assets: This factor affects consumption spending positively and
negatively. Possession of such durable consumer goods as video tape, radio,
cars and television set etc by a consumer, reduces or eliminates his
expenditure on same at least within expenditure negatively. However, the
possession of these durable assets positively affects consumption since they,
encourages consumer to purchase other goods they encourages consumer to
purchase other goods they would not have purchased. Example the possession of
video tape necessitate the purchase of video cassette, video head cleaner etc.
another example is the possession of a car which necessitates the owner
allocating a part of his total expenditure to purchase a fuel spark, plug,
brake, fluid etc on a regular basis.
SUBJECTIVE DETERMINATES OF CONSUMPTION
Apart from the objective quantifiable determinants of
consumption, other factors play a role in determining the aggregate level of
consumption expenditure. These non-quantifiable subjective factors, Keynes
referred to as psychological factors. These factors include
1. Precaution:
Those who intend to provide for exigencies or emergencies engage in lesser
consumption activities than those who do not bother such. Here consumption
expenditure are influenced by consumer feeding about the need to be precautions
about the future.
2. Avarice: Avarice influence on consumption
expenditure can be explained by the desire or otherwise of individuals to
bequeath estate to their succeeding ones. Those who desire to bequeath estate
to their successors engage in less consumption where as those who do not desire
to same tend to consume more than their counterparts that aspire to do so.
3. Social
Pressure/Peer Group Influence: This has to do with the individual’s feeling
regarding the desirability necessity to live up to societal expectation in
terms of his consumption habit or life style. Example in Nigeria where an
individual social standing is determined by the types of cars he owns.
The
individuals’ consumption is also influenced by his peer group. He spires to
maintain a life style that is at par with that of his peers. This is referred
to as peer group influence. This can also be referred as keeping up with the
joneses.
4. Consumer
Expenditure: positive expectation about future income will logically permit
an individual to spend more of his current income on consumption than if his
expectation about future income were negative. If his expectations are
negative, it becomes a rational act to retain from consumption spending in the
present period so as to be able to meet his consumption needs in the future
when his expectation of a fall in income would have been realized. The converse
reasoning holds for an individual with a positive expectation about future
income.
Also consumer’s expectations of the
future course of price movement, expected lower level of prices tend to make
consumers withhold their consumption expenditure in the present period with a
view to taking advantage of the anticipated fall in the price level when it
materializes and vice versa.
Determinates
of savings
Savings
being that portion of disposable income that is not devoted to current consumption.
This definition of savings is regardless of the use to which all such
unconsumed income may be put. Saving occurs only in the absence of consumption
in discussing the determinants of savings therefore, a number of factors can be
undentifeid. These factors are also grouped into:
i. Objective factor
ii. Subjective factor
OBJECTIVE
DETERMINANTS OF SAVINGS
These
are quantifiable and verifiable determinants of savings. These factors include.
1. The level of income: individual with
higher levels of income tend to save
more than those with lower levels. High income levels make it possible for
individuals to meet their consumption demands while leaving them with an equal
high level of unconsumed income (savings).
2. Level of Interest Rate: Where as interest
rate impact negatively on consumption expenditure, its influence on savings is
positive. Low rate of interest constitute a poor returns on savings especially
if such savings are held in form of financial assets such as bank deposits.
Consequently savings tend to be low when the interest rate is low such that it
is not attractive enough to compensate savers for their decision to abstain
from consumption in the current period.
3. Availability of savings facilities:
people’s propensity to save ten to rise with the availability of outlets into
which their saved funds can be channeled. Example, the availability of a saving
outlets like commercial bank can help ginger people’s enthusiasm to save. The
importance of this factor can better be appreciated if we imagine an economy in
which such facilities do not exist to channel savings from savers to investors.
People tend to save more in the presence of savings facilities than if they
were non-existent because it will encourage savers to interact with investors an
interaction that would have been thwarted in their absence.
4. Inflation Rate: the prevailing rate of
inflation largely influences people’s savings decision because of its erosive
effect on the value of saving especially if such savings are held in the conventional
form of bank deposit the reasons is that high rates of inflation erodes the
purchasing power of money thereby discouraging people from savings since the
value of such savings will be wiped out by the deleterious effect of inflation.
Future
expectation of inflation & interest Rate income determines the level of savings
in the cement period. Example
1. expected
higher level of income in the future
will tend to stunt the savings rate in the current period since such
expectations reduce pressure on individuals to “set something aside for the
rainy day”. Example
2. Expecations about the future course of interest
rate also tend to influence savings behaviour individual reduce their
propensity to consume with a view taking advantage of the expected higher
interest rate when it is realized. So do lower expected interest rate in the
future tent to elicit more savings in the present period since savers will act
to take advantage of the higher interest rate in the current period relative to
the expected tower rate in the future.
Example .
3. Expectations
about the future course of inflation rate influence individual’s savings
decisions in the present period. Expectations of high rates of inflation could
gagmen individual’s enthusiasm to save since the value of their savings in the
future period when the expectation about inflation have been realized will be
worthless than its value in the current period when the savings decisions were
implemented. On the other hand however, inflationary expectations could prompt
individual to save more in the present period so as to be able to use their
increased savings to cushion the therefore from these analysis execratively
about the future course of certain factors largely influence savings behaviour
in the present period.
3. SUBJECTIVE
DETERMINANTS ON SAVINGS
These are the non-quantifiable and non-traceable
factors that inflation savings largely. They are psychological in nature. These
factors include
1. the
instinct for precaution: Individuals who bother about the unknown future would
tend to be more precautions in their consumption propensity in the current
period than individuals who do not their desire to proved for the unknown
future propels them to devote a greater proportion of their of their income to
savings than would be deviled by individuals who are less futuristic in their
outlook. The concept is the relater the individual’s instinct for precaution
with respect to the unknown future, the higher has savings rate will be.
1. Cultural
factors and Habit where it is the norm for individuals in society to abstain
from consumption the savings rate tend to be characterized by ostentations way
of life with emphasis
3. Desire
for Bequest : Individuals who wish bequeath a portion of their life earrings to
their success dings ones tend to save more than those who do not aspire to do
same. Individual in this category tend to consume a greater proportion of their
income since they seem to be careless about their successors.
“In 1961-1880 the role of actual price level (inflation)
in determining the savings behaviour in Nigerian economy cannot be said to be
strong” according to Iyahen.
He
detected also that “a some what positive relationship between expected
inflation and the level of personal, savings” on the relevance of existence of savings
outlet in influencing savings behaviour, he concluded that although this
variable implying that “a larger number of banks in Nigeria may encourage savings
behaviour”. It was a weakly significant determinant. In addition he found out
that the income variable “ is positively related to savings which indicates
that people are more willing and able to increase their savings when their
income is high than when it is low” this is quite truth because a higher disposable
income encourage positive attitudes towards savings.
Finally,
an empirical study by the World Bank taken in certain countries showed that
personal savings mobilization was susceptible to the influence of real interest
rate. Infact, it was showed that savings responds to substantial increases in
interest rate.
SUMMARY
Consumption is the major component of aggregade demand
consumption and savings is the one to the relationship between consumption and
saving the determinant work, the opposite to saving line.
These
factors are also responsible for rise and fall in investment sector of the Nation
Consumptions clearly reacts to economic climate individuals and household
consumption varies in value and composition. An increase of consumption raises
gross demotic product (GOP) by the same amount. We have the conceptual
framework that determines consumption expend the absolute income hypothesis determine
that current income consumption expenditure is a function of current disposable
income, as income increases, consumption expenditure increases but at a decreasing
rate.
Relative
income hypothesis postulate that one’s consumption behaviour is influenced by
that of his neighbour or environment permanent income hypothesis states that
consumption is a function of permanent income rather than current disposable income
life cycle hypothesis that consumer allocates his income so as to maximize
satisfaction over his life time.
REFERENCES
Adetotun P.
(1978): “Nigerians public consumption expenditure; the journal of economics and
social studies
Anyanwu, C.,
(1995): Theory and application in Nigeria” modern macro economics
Anyanwu, C.,
(1995): “Revenue allocation and stable fiscal Federalism in Nigeria” journal of
economic management, 2(2) 1-28.
Davial, T. E
(1952) “The consumption function as a tool for prediction” Review of economics
and statistics, pp. 270 – 277.
Hall (2001) “
Stochastic implications of the life-cycle, permanent income hypothesis: theory
and evidences” Journal of political economy.
Jhingal, M.L
(2003): Macroeconomics Theory. New Delhi, 12th enlarged revised edition.
Koutsoyiannis, A.
(1985) An introduction of econometrics’, Macmillan
Koutsoyiannis, A.
(2001): Theory of econometrics palgrave publisher, 2nd edition, pg
105.
Okechukwu, O.
(1998) “An examination of the Keynesian consumption function in Nigeria,
1975-1994” Rivers journal of the social sciences. Pp 34-42.