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Consumption and Investment Role in Economy Essay


“One of the crucial areas of economics is the study of the relationship among investment, consumption, and growth” (Bao et al, 287). Just like Bao et al, Jorgenson (274) also argues that “the overall product of a given economic system comprises of investment in both human and non-human capital and consumption of the market and non-market goods and services”. From the definitions provided above, it is evident that consumption and investment play a significant role in GDP growth rate derivations. For an economy to balance, funds opt to be allocated properly between investment and consumption. Overreliance on one side often leads to complications. For instance, if a lot of funds are allocated to investment alone, consumption will automatically lag. Unfortunately, the lagging behind of consumption is often associated with low demand, a de-motivating factor for any increase in productivity. Thus, both consumption and investment must be given equal importance.

Various factors are used to determine the amount of consumption expenditure; some of them include the level of disposable income, availability of credit, and expectations. Wealth, interest rates, stock of durable consumer, and income distribution also play a significant role in determining consumption. “For instance, good credit conditions often favor consumer spending whereas, low interest rates stimulate consumer spending” (Bao et al, 289). Additionally, consumer spending is also affected by not only the expectation of future changes in price but also the existing stock of long-lasting consumer supplies.

Just as consumption, numerous factors also play a significant role in determining the amount of investment expenditure. Some of them include the rate of interest, retained earnings, expectations, and the level of national income. The level of profits, the rate of technological change, and the rate of change of national income also play a significant role in determining investment spending. On most occasions, low investment rates encourage investment whereas high-interest rates discourage individuals from investing. Additionally, an increase in profit is often associated with an increase in investment spending.

“In the field of economics, changes in consumption and saving are measured by either marginal propensity to consume (MPC) or marginal propensity to save (MPS)” (Boyes and Melvin, 187). MPC is a fraction of extra income that an individual uses for consumption. “It is often calculated by a diving change in consumption by the change in income” (Boyes and Melvin, 187). For instance, if the additional income of an individual is $200 and $100 as an additional consumer spending, then MPC will be equals to 0.5.

MPC=change∈consumption/ change∈income

MPS on the other hand is the extra income that an individual diverts to saving. “MPS is calculated by a diving change in saving by the change in income” (Boyes and Melvin, 187). For instance, if an individual receives $200 and sets aside $20 of it, then MPS will be equal to 0.1.

MPS=change∈saving/ change∈income

The MPC and the MPS also play a significant role in determining a change in income. The changes in consumption and saving account for all changes that are encountered in income. Thus, the sum of the MPC and the MPS is often 100 percent of the change in income. In determining the change in income, the MPC and the MPS also enable individuals to differentiate and explain the consumption behavior of given individuals. For instance, “a short-run consumption function has a lower MPC than a long-run consumption function because of lack of complete adjustment of a given consumption behavior” (Boyes and Melvin, 193).

Works Cited

Bao, Shuming et al. The Chinese Economy After Wto Accession. Edinburg: Ashgate Publishing, Ltd., 2012. Print.

Boyes, William and Melvin, Michael. Macroeconomics, 9th ed. New York: Cengage Learning, 2012. Print.

Jorgenson, Dale. Productivity: Postwar U.S. economic growth, Volume 1. New York: MIT Press, 1995. Print.

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IvyPanda. (2020) 'Consumption and Investment Role in Economy'. 1 October.

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