Economics for Managers
Essay by pradumna.shukla • January 15, 2016 • Term Paper • 1,036 Words (5 Pages) • 966 Views
Distinguish Between Savings and Investment
Savings and Investments are two very different things, however frequently confused as same.
Savings | Investments |
Saving money means keeping aside a part of your income regularly in order to meet up with unexpected expenses in the near future. | Investment means putting that money in various financial products to earn a return and be able to grow your wealth. |
Savings are meant for short term needs such as emergency situations or unexpected expenses. | Investments are generally done in a longer horizon period comprising of six months or more so that you can get good returns and grow your wealth. |
Savings have very low risk | Investments could be from moderate to very high risk. |
Savings have negligible or very low return | Investment, if done wisely, offers very good returns and wealth can increase manifold. |
Savings are the most liquid assets as they could be accessed at any point of time. | Depending on the type of investment, it could take a few days or more for your assets to turn liquid. |
Examples: Savings account, Fixed Deposits, post office monthly Income scheme, National Savings Certificate, Company Fixed Deposits etc. | Examples: Mutual Funds, Gold, ETF’s, Infrastructure Bonds, Stocks and shares, Real Estate etc. |
Paradox of Thrift
The paradox of thrift, also known as the paradox of saving is a concept popularized by British Economist John Maynard Keynes. It states that if everyone tries to save more money during times of economic recession, then the aggregate demand will fall leading to low consumption, lower economic growth, higher unemployment due to fall in demand and low income.
Hence, despite attempts to save more money, total savings for the whole population would be low.
Keynesian income determination model assumes that an economy is an advanced capitalist economy and the model is extended while discussing paradox of thrift.
- Underlying assumptions of the Paradox
- The economy in question is a closed economy with no trade and no investment option available outside.
- The economy under purview is a highly advanced economy with a failed financial system in which people have lost faith.
- As people lose faith in the country’s financial system, they start to store money as a precautionary measure by investing in gold, oil, art etc. generating scarcity rents for those who can offer perceived value stores, but nothing in the way of general income or employment.
Example of Paradox of thrift:
In the 70’s and 80’s, Japan was at the forefront of world economy winning the war. From electronics to Automobiles the Japanese brands could do no wrong. Soon Japanese brands like Toyota and Sony were household names across the world. Japanese management practices were being copied and there were many best sellers on the rise of Japan.
But then in 1990’s the Japanese juggernaut stalled. Sales and exports declined and Japanese economy went into recession, a recession that lasted almost a decade. The reason for the recession was that Japanese being very cautious on the economy curtailed spending. As the exports were falling, the Japanese consumers increased the saving rate, to brace themselves for the tight days ahead. This led to lesser spending in the local economy and further loss of business for the local Japanese establishments. So now not only the exporters were facing loss of sales but also the local businesses were losing business. This led to further recession something that lasted for more than a decade.
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Significance of Paradox of Thrift on Developed Economies:
Paradox of thrift has a very high significance in developed economies. Since the economies are consumption based economies and supply of goods is very highly determined by the demand generated. Hence in a developed economy unemployment and low growth results due to decrease in consumption as a result of collective savings. Also the economy under purview has idle capital goods available which could be properly utilized if and only if an effective demand could be generated.
American recession of 2008 is a good example of this paradox. As credit crunch started, people started to save more and more to clear of their debts rather than spend. This caused a reduction in the income of business which led to layoffs and increase in unemployment. Also, large banks and corporate houses started to save money by laying-off employees and cancelling/postponing business expansions to improve the health of their balance sheets. This further deepened the credit crunch by reducing the net income and hence savings. The only effective way out of it would have been to spend on the economy which was started by the American government as a massive stimulus programme.
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