Consumption and Investment

Consumption, saving, and investment playar central role in a nation’s economic performance. Nations that save and.invest large fractions of their incomes tend to have rapid growth of output, income, and wages; this pattern characterized the United States in the nineteenth century, Japan in the twentieth century, and the “miracle” economies of East Asia in the last three decades. By contrast, nations which consume most of their incomes, like many. poor countries in Africa and Latin America, invest little in new plant and equipment and show low rates of growth- of productivity and wages. High consumption relative to income spells low investment and slow growth; high saving leads to high investment and rapid growth.

 The interaction between spending and income plays quite a different role during business cycle expansions and contractions. When economic conditions give rise to rapidly growing consumption and investment, this increases total spending or aggregate demand, raising output and employment in the short run.  America’s economic boom of the late 1990s was largely fueled by rapid growth in consumer spending. And when consumption falls because of higher taxes or loss of consumer confidence, as happened in Japan in the 1990s, this tends to reduce total spending and may produce a recession. Because consumption and investment are so central to macroeconomics, we devote this chapter to them. Figure 22-1 shows how this chapter’s analysis fits into the overall structure of the economy.

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