Planned and Actual Saving and Investment Difference

This article will help you to learn about the difference between planned and actual saving and investment.

Difference between Planned and Actual Saving and Investment

A. Planned Saving and Planned Investment:

The savings which are planned (intended) to be made by all the households in the economy during a period (say, a year) in the beginning of the period is called planned (or ex-ante) savings.

The amount of planned (or desired) savings is given by saving function (i.e., propensity to save).

The investment which is planned or desired to be made by the firms or entrepreneurs in the economy during a period (say, a year) in the beginning of a period is called planned (or ex-ante) investment. The amount of planned (or desired) investment is given by investment demand function (i.e., relationship between investment demand and rate of interest).

The following points are noteworthy:

(a) Equilibrium in the economy occurs only when planned investment and planned savings are equal. Ex-ante savings and investment may or may not be equal. It is only when ex-ante savings = ex-ante investment that equilibrium takes place. It means economy invests what it has saved. Such equilibrium is rare because savers and investors are different people who save and invest with different motives. (Mind, actual savings and actual investments are always equal at all levels of income.)

(b) When planned saving is not equal to planned investment, i.e., when planned spending is not equal to planned output, then output will tend to adjust up or down until the two are equal again.

Adjustment Mechanism (when planned savings is not equal to planned investment):

(i) When planned (ex-ante) saving is more than planned investment:

Excess of planned savings (say, 25,000 crore) over planned Investment (say, 20,000 crore) means that expenditure in the economy is less than what producers had expected.

This would result in undesired build-up of unsold stock. Consequently, AD falls short of AS. Due to excess supply resulting from be stock piling of unsold goods, i.e., unintended inventories, the producers will cut down employment and will produce less. National income will fall and as a result planned saving will start Jailing until it becomes equal to planned investment. It is at this point that equilibrium level of income is determined.

(ii) When planned (ex-ante) saving is less than planned investment. Suppose producers plan to invest Rs 25,000 crore but households plan to save Rs 20,000 crore, then AD (or consumption expenditure) is more than AS. Production will have to be increased to meet the excess demand.

Consequently, national income will increase leading to rise in saving until saving becomes equal to investment. It is here that equilibrium level of income is established because what the savers intend to save becomes equal to what the investors intend to invest.

Sum and substance is that if planned saving and planned investment are equal, then output, income, employment and price level will be constant. According to Keynes, it is the difference between planned saving and planned investment which causes fluctuation in the levels of output, income and employment. To maintain equality between the two, he advocated fiscal policy.

For instance, if private investment declines leading to fall in income and employment, government should fill up the gap by increasing its own expenditure on public works. As against this, if private investment exceeds private saving, even after the stage of full employment, government should increase taxes and reduce public expenditure.

B. Actual Savings and Actual Investment:

Actual saving is the actual amount of savings that took place measured after the fact:

Alternatively, ex-post (actual) savings are those which the households actually save from their income. In short, realised savings of a period, say, a year, are called actual (or ex-post savings).

Actual investment is the actual amount of investment that took place measured after the fact:

Alternatively, it refers to actual investment made by all the entrepreneurs in the economy during a given period. In short, the realised investment of a period, say, a year, is called actual investment (or ex-post investment). In Keynesian terminology, investment means real and non-financial investment.

The point to be noted is that ex-post investments of firms are always equal to ex-post savings by households at all levels of income as savings finance investments. Ex-post or realised (or actual) saving and investment are necessarily equal and this is brought about by fluctuations in income. Since unplanned investment also gets included in realised investment, therefore, realised investment is always equal to realised saving.

This equality is proved from the following equations:

Y (Realised income) = C + S (Realised saving)

Y (Realised income) = C + I (Realised investment)

C + S = C + I

S [Realised saving] = I (Realised Investment)

It needs to be noted that in macroeconomics, savings and investment do not refer to saving and investment by individuals but they refer to the saving and investment of the whole community or economy.

C. Difference between Ex-ante (Planned) and Ex-post (Actual) Investment:

Ex-ante or planned investment is the investment which is desired to be made by the firms and planners in the economy during a particular period in the beginning of the period. It is the amount of planned investment, given by the investment demand function [i.e., relation between investment demand and rate of interest).

Ex-post or actual investment of a period [e.g., a year), measured after the fact is called actual or ex-post investment. It is noteworthy to mention that Keynes included in the investment of unsold goods which he called unplanned investment. Thus, actual investment equals planned + unplanned investment. It should be kept in mind that sometimes investment is made which was not included in the planned (intended) investment.

This type of investment is called unplanned investment. Unplanned investment takes place when unsold finished goods accumulate due to poor sales. Thus, actual investment of an economy is the total of planned investment and unplanned investment.

Symbolically:

Actual investment = Planned investment + Unplanned investment

Hence, actual investment may differ from planned investment because of unplanned addition or reduction in inventories (stock of goods).