Gross domestic savings, Macroeconomics


Gross Domestic Savings 

Income not devoted to current consumption is saved. In an economy during a particular year some units will consume less than their income while some will spend more than their income. Gross domestic savings is the difference between GDP and aggregate consumption.It is interesting to note that while most of the consumption can be attributed to the household sector, saving is done by various sectors of the economy. This is because part of the income generated in the productive process does not reach the households. Retained profits remain with the business units where they are generated. They constitute part of 'business savings'. Government takes away some income in the form of taxes which constitutes bulk of government revenue. By not spending all of it on current goods and services government can generate savings. Gross Domestic Savings is the total of savings done by all sectors of the economy.The relationship between aggregate savings (S) and income (Y) is known as the saving function, i.e. S = S(Y). Saving may be related to either national or disposable income. The properties of the saving function are the inverse of those of the consumption function, since Y = C + S.

.Gross Domestic Capital Formation
Production requires services of fixed assets such as machinery, equipment and structures as well as working capital i.e. stocks of raw materials, work in process, finished goods, etc. The act of replacing worn out assets and creating new assets is capital formation. Gross domestic capital formation (GDCF) consists ofi

I. Making good the depreciation on existing fixed assetsii

II. Adding to the stock of fixed assetsiii

III. Adding to inventories. 

Sometimes the first two of these together are called gross fixed investment while the third is called inventory investment. The word investment can be misleading. When you buy a corporate share on the secondary market (i.e. an existing share) you are making an 'investment' in the popular sense of the word. However, this may not lead to any capital formation at all; the person who sells the shares might spend the entire proceeds on current consumption. All that has happened is ownership of a part of existing assets has changed hands. We are concerned with replacement and new additions to physical assets not merely financial assets nor transfer of ownership of existing assets.

Bulk of domestic capital formation is financed from gross domestic savings (GDS). However, GDS need not equal GDCF. Domestic savings may be loaned to foreigners and contribute to capital formation abroad; conversely, foreigners may loan their savings to us for capital formation here. In the former case GDS will exceed GDCF, in the latter case GDCF will exceed GDS.

Treatment of a class of goods called consumer durables is problematic. When you buy a refrigerator, are you spending on current consumption or investing in a physical asset? Strictly speaking, it is the latter because you consume refrigeration service yielded by the refrigerator not the refrigerator itself, and the refrigerator will continue to yield such services over a number of years, just as a machine tool yields services over a number of years. However, it is the practice in many countries to regard expenditure by households on many consumer durables as consumption expenditure. The same refrigerator if it were bought by the research laboratory of a pharmaceutical company would have become 'capital formation'.If depreciation is subtracted from GDCF we get another aggregate called net capital formation.

It just indicates net additions to the stock of fixed assets. 

Posted Date: 9/11/2012 5:36:08 AM | Location : United States

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