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ECONOMIC RECOVERY TAX ACT: Unofficially called the Kemp-Roth, this was a cornerstone of economic policy under President Reagan passed in 1981. The three components of this act were: (1) a decrease in individual income taxes, phased in over three years, (2) a decrease in business taxes, primarily through changes in capital depreciation, and (3) the indexing of taxes to inflation, which was implemented in 1985. This act was intended to address the stagflation problems of high unemployment and high inflation that existed during that 1970s and to provide greater incentives for investment. A primary theoretical justification is found in the Laffer curve relation between tax rates and total tax collections.

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INDUCED SAVING:

Household saving that depends on income or production (especially disposable income, national income, or even gross domestic product). That is, changes in income induce changes in saving. Induced saving reflects the fundamental psychological law put forth by John Maynard Keynes. It is measured by the marginal propensity to save (MPS) and is reflected by the positive slope of saving line. The alternative to induced saving is autonomous saving, which does not depend on income.
Induced saving is saving by the household sector that is based on the level of income or production. This is one of two basic classifications of saving. The other is autonomous saving, saving that is NOT based on the level income or production. In other words, household saving can be divided into: (1) a baseline amount of saving which, in theory, would be undertaken even if the household sector had no income and (2) additional saving that results from the income available to the household sector.

Saving is induced because people are prone to divert a portion of the income they have away from consumption. They do so in response to interest payments and to accumulate future purchasing power. If they have more income, then they are inclined (that is, induced) to save more. If they have less income, then they save less. Induced saving simply means that income is the most important factor affecting saving. Other factors are important, but income is at the top of the list. People cannot save if they have no income.

Induced saving is a complement to induced consumption. An increase in income induces the household sector to increase both consumption AND saving. This reflects the fundamental psychological law that John Maynard Keynes proposed as an essential difference between his theory and classical economics. He contended that people spend a substantial portion of extra income, but not all. The part not spent is diverted to saving.

Induced saving is reflected by the slope of the saving line and the marginal propensity to save (MPS). The MPS plays a key role in the value of the expenditures multiplier.

Induced Through An Equation

One way to illustrate induced saving is with the saving function, such as the equation presented here:
S=c+dY
where: S is saving, Y is income (national or disposable), c is the intercept, and d is the slope.

The two key parameters that characterize the saving function are slope and intercept. Induced saving is indicated by the slope of the saving function. Autonomous saving is indicated by the intercept.

  • An Induced Slope: The slope of the saving function (d) measures the change in saving resulting from a change in income. If income changes by $1, then saving changes by $d. This slope is generally assumed and empirically documented to be greater than zero, but less than one (0 < b < 1). It is conceptually identified as induced saving and the marginal propensity to save (MPS).

  • An Autonomous Intercept: The intercept of the saving function (c) measures the amount of saving undertaken if income is zero. If income is zero, then saving is $c. The intercept is generally assumed and empirically documented to be negative (a < 0). It is conceptually identified as autonomous saving.
The connection between consumption and saving shows up in the saving function. The consumption function is commonly specified as:
C=a+bY
where: C is consumption expenditures, Y again is income, a is the intercept, and b is the slope.

Because income not spent is saved, the saving function can be specified as:

S= -a+(1-b)Y
where: S is saving and Y is income. However, now the intercept is -a rather than c and the slope is (1-b) rather than d. This alternative specification shows the connection between the saving function and the consumption function. The intercept of the saving function (-a) is the negative of the intercept of the consumption function (a). The slope of the saving function (1-b) is one minus the slope of the consumption function (b), meaning that extra income induces and is divided between consumption and saving.

Induced Through A Line

Saving Line
Saving Line

Another common way to identify induced saving is with a standard saving line, such as the one presented in the exhibit to the right. This is reasonable because the saving line is a graph of the saving function. The red line, labeled S in the exhibit, is the positively-sloped saving line for the equation: S = -1 + 0.25Y. This line indicates that greater levels of income generate greater saving by the household sector.

The two primary characteristics of the saving function--slope and intercept--are also identified by the saving line.

  • An Induced Slope: The slope of the saving line presented here is positive, but less than one. In this case the slope is equal to 0.25. Click the [Slope] button to highlight. Once again this is induced saving and the marginal propensity to save (MPS).

  • An Autonomous Intercept: The saving line intersects the vertical axis at a negative value of -$1 trillion. Click the [Intercept] button to highlight. And once again this is autonomous saving.

Other Induced Expenditures

Saving is only one of several induced variables that enters into the study of Keynesian economics. Of course, the complement of saving, consumption, is perhaps the most important induced variable. The other three aggregate expenditures--investment expenditures, government purchases, and net exports--are also induced by income and production.
  • Investment is induced by income because an expanding economy generally boosts business profit, which is then used for investment expenditures on capital goods.

  • Government purchases are induced by income because extra income generates more tax revenue (especially state and local tax revenue), which is then used by government to finance expenditures.

  • Net exports, the difference between exports and imports, are induced through imports, which are induced in the same fashion as saving. An increase in income is not just used to purchase domestic goods, but also imported goods.
Other components of the macroeconomy are also related to, or induced by, income and production. One important induced component is taxes. In particular, sales and income taxes are directly related to income. More income invariably means more taxes. Another induced component is the demand for money. Because expenditures use money, an increase in income not only induces expenditures, it also induces the demand for money.

<= INDUCED NET EXPORTSINDUSTRY =>


Recommended Citation:

INDUCED SAVING, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: April 21, 2014].


Check Out These Related Terms...

     | autonomous saving | saving function | saving line | marginal propensity to save | induced consumption | induced expenditures | induced investment | induced government purchases | induced imports | slope, saving line | intercept, saving line | effective demand | psychological law | injections | leakages |


Or For A Little Background...

     | Keynesian economics | circular flow | aggregate expenditures | saving | consumption expenditures | personal consumption expenditures | macroeconomics | household sector | disposable income | national income | gross domestic product |


And For Further Study...

     | aggregate expenditures line | average propensity to save | derivation, saving line | derivation, consumption line | consumption expenditures determinants | Keynesian model | Keynesian equilibrium | injections-leakages model | aggregate demand | paradox of thrift | fiscal policy | multiplier |


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