Readers Question: what is the difference between saving and investment?
Saving involves income that is not consumed. Typically surplus income is saved in a bank account. But, it could be saved as cash (cash under the bed e.t.c)
The Savings Ratio is the % of income that is saved. In recent years the UK and US have had low savings ratios as people have been encouraged to borrow and spend more. The credit crunch and impending recession are encouraging more to save.
Levels of savings are influenced by
- Interest rates – higher interest rates make it more attractive to save
- Confidence – low confidence can encourage households to save more
Investment in economics is defined as an addition to the capital stock. (Gross fixed capital formation) For example, investment can involve spending on factories or new capital. Investment can also involve spending on human capital such as investment in training and education.
Levels of investment are affected by
- Interest rates – higher interest rates make investment more expensive (cost of borrowing goes up)
- Confidence – if firms are confident, they are more willing to invest.
- Economic growth – An increase in the rate of economic growth will encourage firms to invest to meet future demand.
Note: In everyday terminology, people refer to investing money in a bank, however, this does is not investment in an economic sense. It is saving.
Saving = investment
In neo-classical economics, it is assumed that the level of saving will equal the level of investment. This is because investment is determined by available savings in the economy.
If there is an increase in savings, then banks can lend more to firms to finance investment projects. In a simple economic model, we can say the level of saving will equal the level of investment.