Question

Explain the intuition underlying the response of desired saving to each of the following

scenarios.

a. Current income decreases.

b. The stock market booms resulting in a very large increase in wealth overnight.

Answer 1

Saving is a portion of income which deducted from total income after allotted for consumption. In simple terms, savings is consumption minus income. Savings is the function of interest rate and it is positively related to level of income. If income increased, the desire of people to save will increase.
a) Here the level of income decreased, thus the desired level of savings will fall down. A minimum level of income, most of the consumers will try to fulfil their consumption needs. They will give small preference for savings. There consumption level also becomes reduced than before. As mentioned above, there is direct relation exist between level of income and savings. The savings function curve become steeper at this situation.
b) The boom occurred in overnight over the stock market will raise the demand for stocks with a huge fall in its price. Most of the people will tried to buy more stock market securities and this will become added to the overall savings of the nation. The desired savings level will increase. At the same time, this boom will increase the investment level also.