If the equality between planned savings and planned investment is disturbed by increase in savings, then the immediate effect will be that the stocks of goods lying in the shelves of the shops will increase (as some of the goods will not be sold due to the fall in consumption i.e., increase in savings). Now, what will happen if planned investment expenditure falls short of the planned savings?Īs a result of fall in planned investment expenditure, income, output and employment will fall and therefore the flow of money will contract. Therefore, planned savings must be equal to planned investment if the constant money income flow in an economy is to be obtained. For the circular flow of income to continue unabated, the withdrawal of money from the income stream by way of saving must equal injection of money by way of investment expenditure. In other words, investment is injection of some money in circular flow of income. On the other hand, investment means some money is spent on buying new capital goods to expand production capacity. Economists therefore call savings a leakage from the money expenditure flow. Thus, savings reduce the flow of money expenditure to the business firms and will cause a fall in economy’s total income. This will lead to the fall in total incomes of the households. With reduced money receipts, firms will hire fewer workers (or lay off some workers) or reduce the factor payments they make to the suppliers of factors such as workers. When households save, their expenditure on goods and services will decline to that extent and as a result money flow to the business firms will contract. We will now explain if households save a part of their income, how their savings will affect money flows in the economy. A result, circular flow of money speeding and income remains undiminished. In our above analysis of the circular flow of money we have assumed that all income which the households receive, they spend it on consumer goods and services. In fact we have explained above the flow of money that occurs in the functioning of a closed economy with no savings and no role of government.Ĭircular Money Flow with Saving and Investment : In other words, in our above analysis we have not taken into account the role of foreign trade. Thirdly, we assume that the economy neither imports goods and services, nor exports anything. In other words, the government does not receive any money from the people by way of taxes, nor does the government spend any money on the goods and services produced by the firms or on the resources and services supplied by the households. We further assume that the government does not play any part in the national economy. In the first place, we assume that neither the households save from their incomes, nor the firms save from their profits. In order to make our analysis simple and to explain the central issues involved, we take many assumptions. In year of depression, when national income is low, the volume of the flow of money will be small and in years of prosperity when the level of national income is quite high, the flow of money will be large. This is so because the flow of money is a measure of national income and will, therefore, change with changes in the national income. In year of depression, the circular flow of money income will contract, i.e., will become lesser in volume, and in years of prosperity it will expand, i.e., will become greater in volume. In other words, the flow of money income will not always continue at a constant level. It may, however, be pointed out that this flow of money income will not always remain the same in volume. This circular flow of money will continue indefinitely week by week and year by year. Thus there is, in fact, a circular flow of money or income. Thus we see that money flows from business firms to households as factor payments and then it flows from households to firms. In the lower part of the figure, money flows from households to firms as consumption expenditure made by the households on the goods and services produced by the firms, while the flow of goods and services is in opposite direction from business firms to households. In opposite direction to this, money flows from business firms to the households as factor payments such as wages, rent, interest and profits.
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