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Saving-Investment (S-I) Approach

Last Updated : 03 Apr, 2023
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Saving means storing money safely for the future so that when one needs money, it is available for them. However, Investment means putting one’s money to work in financial instruments like bonds, shares, etc., to grow money over time. Saving-Investment Approach (S-I Approach) is used to determine the equilibrium level of income, output, and employment in an economy.

Determination of Equilibrium Level

The Keynesian Theory states that the equilibrium situation is usually expressed in terms of Aggregate Demand (AD) and Aggregate Supply (AS). However, the equilibrium can also be determined when saving (S) is equal to the investment (I). 

Simply put, equilibrium is attained when:

AD = AS

Now, we know that,

AD = C + I,

and AS = C + S

Therefore,

C + S = C + I

i.e., S = I

Assumptions

The various assumptions used to determine equilibrium output are:

  1. The determination of the equilibrium level will be examined using a two-sector model (households and firms). Simply put, it is assumed that there is no foreign industry or government in the economy.
  2. It is also assumed that investment expenditure is autonomous, i.e., that income level does not have any impact on investments.
  3. It is assumed that the pricing level is constant.
  4. Also, to determine equilibrium output, short-run will be considered.

Saving-Investment Approach (S-I Approach)

The Saving-Investment Approach states that when the planned saving (S) is equal to the planned investment (I), the equilibrium level of income in an economy is established. 

Example:

Saving and Investment Approach

 

S-I Approach

 

The Investment curve in the above graph shows the autonomous investment made; therefore, it is parallel to the X-axis. The Saving Curve S slopes upward, which means that saving increases with an increase in income. At point E where the investment curve intersects the saving curve, the economy is in equilibrium.

Observations:

  • The equilibrium point, denoted by the letter E, occurs where saving and investment curves intersect each other.
  • Also, at point E, ex-ante saving is equal to ex-ante investment.
  • The equilibrium level of output corresponding to the equilibrium point E is OY.
  • In the above table, planned saving is equal to planned investment; i.e., ₹30 Crores, when the equilibrium level of income is ₹200 Crores.

Readjustment Process

When there is any deviation from the equilibrium level of income; i.e., if the planned saving or S is not equal to planned investment or I, then to bring them equal to each other, the process of readjustment is started in the economy.

1. When Saving is more than the Investment

In the above graph (example), if planned saving (S) exceeds planned investment (I) (after point E), it implies that households are not consuming as much as the businesses expected, which results in an increase in the inventory level above the desired level. Therefore, to get rid of the unwanted increase in inventory, until saving and investment become equal to each other, companies would plan to reduce output.

2. When Saving is less than the Investment

In the above graph (example), if planned saving (S) is less than planned investment (I) (before point E), it implies that consumers are likely consuming more and saving less than what businesses expect, which results in a reduction in the inventory level below the desired level. Therefore, in order to bring the inventory back to the desired level, until saving and investment become equal to each other,  firms would plan to increase output.


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