 factors affecting consumption and saving, current and expected future income, wealth, effects of changes in current income. Dear students, an increase in current income will increase both consumption and saving. How much consumption will increase and how much saving will increase? It depends on the marginal propensity to consume and obviously marginal propensity to save. What is the relationship between the two? 1 minus Mpc is Mps and vice versa, i.e. Mpc plus Mps is equal to 1. Mpc means, if you are familiar with the concept, that when one unit increases in a person's income, then how much change is there in consumption? Change in C divided by change in pi. And usually its value remains between 0 and 1. If it is 1, it means that change in Y is equal to change in C. And if it is 0, it means that the amount of income that has been added has been saved. So usually it lies between 0 and 1. Suppose if it is 0.7, it means that if one unit increases in income, then 70% of that increase will be used for consumption purposes and the remaining 30% will be for saving purposes. So, how much is the value of Mpc? How much is the value of 1 or 0? How much does it depend on? Obviously it depends on the scale, people's willingness to defer satisfaction. If it is 0.7, it means that 30% of today's income will be used for future consumption. If it is 0.4, it means that a larger portion will be used for future consumption. So, what is the value of Mpc? How do people maximize their lifetime utility? Individuals, in fact, keep an eye on their total lifetime utility and they want to maximize it. So, whatever the value of Mpc is. If it is 0.7, it means that they want to prioritize their lifetime utility. Similarly, the assessment of their current and future needs will determine the value of Mpc. So, we were talking about the aggregate level. So, your national income will increase. So, this increase in national income will increase your desired consumption. But this increase in consumption will be less than the increase in income. The value of Mpc usually lies between 0 and 1. It remains below 1. So, the increase in consumption will be less than the increase in income. So, this means that when the income increases, both things will increase. The consumption will also increase and your national saving will also increase. So, we will see that if a person's current income increases, how will it affect his consumption and saving? If a person's current income increases, his current consumption will also increase and his current saving will also increase. But if his future income increases, he is expecting that his income will increase in the coming days. So, how will this affect his consumption? The important principle in this context is the smoothing motive. Every person wants his lifestyle to be smooth. There are many fluctuations that do not occur. Rather, gradually, there is an improvement. So, when he expects that his future income will increase, or it will increase, then what will he do? He will increase his current consumption. As a result of increasing his current income, he is expecting that his future income will increase. As a result of increasing his future income, he is increasing his current consumption. So, what will happen in this context? His current consumption will increase but his current consumption and his current saving will decrease. You do not understand that by increasing his current income, his current consumption and his current saving will increase. As a result of increasing his future income, his current consumption increases and his current saving will decrease. This is the difference that you understood. Why does his current saving decrease? Because his income does not increase and his consumption increases, obviously, his current saving will decrease. After this, we will see that if a person does not have an income, but his wealth, then what will be the impact of his consumption and his current saving? Do you understand the difference between income and wealth? The income is a kind of flow concept. How much money is earned on a monthly basis every week? Whereas, wealth is a stock concept for income. A person's wealth is always calculated with a particular point in time reference. What is his wealth today? When we measure his income, it is from a time period, whether it is monthly or weekly or whatever his annual income is. In economics, you know that there are two kinds of concepts. Flow and stock variables. So, income is a flow variable and wealth is a stock variable. So, a simple definition of wealth is that what are the total assets of a person? And if we subtract his liabilities from that, then he will have total wealth. In wealth, there may not be any additional expenses. One very common thing is that when a boom comes in the stock market, then these people have additional expenses in their wealth. So, we will see what will be the impact of people's consumption on wealth. So, even with the increase of wealth, people's current consumption will increase. Why will it increase? People will feel rich themselves. Their income did not increase, but wealth has increased. So, now they do not need to save much for the future. Why were they saving so that they could increase their wealth in the future? They wanted to improve their lifestyle. For that, wealth is available to them. So, because of the increase of wealth, they will increase their current consumption. And just like we saw in the last slide, the increase of income in the future also increased the current consumption. But with that, the current savings will decrease. So, the impact of wealth will be the same. Because of the increase of wealth, the current consumption will increase and the current savings will decrease. Because how do we measure the savings? How much has changed in your savings with reference to change in income? Income is not big. Because of the increase of wealth, the savings will decrease. We want to see one more thing. When the interest rate is changed and when the government puts in taxes, what impact does the savings have on savings? In this context, the concept we will discuss is expected after tax real interest rate. Look at this equation. We are using R for real interest rate. And I am using this for nominal interest rate. T for tax rate. And pi with exponent E. This is for expected inflation rate. I repeat this. R for real interest rate. I for nominal interest rate. T for tax rate. And pi E is the expected inflation rate. In R's subscript, we have written A, T. Meaning after tax. Real interest rate after tax. What will be equal? 1 minus T. T tax rate multiplied by nominal interest rate. And when you minus expected inflation, you will get after tax real interest rate. Okay. So, we are taking numerical values. Nominal interest rate we are assuming is 5%. And expected inflation rate is 2%. Okay. In the first example, we are assuming tax rate is 30%. The government that is earning from our interest rate, we have to pay the government 30%. So, after tax nominal interest rate what will happen? 1 minus T times I. T is 30% 0.3. 1 minus 0.3 multiplied by 5. So, we will calculate this. 3.5%. So, you have nominal interest rate 5%. And after tax nominal interest rate will be 3.5%. And this 30% will be taken by the government in the form of tax. And if you want to calculate real tax rate, why are we using expected value? Because we are using expected inflation value for future inflation. So, this will be expected after tax real interest rate. Okay. Now, after tax nominal interest rate, we will minus expected inflation, which we assumed is 2%. So, you will get 1.5%. So, I am repeating this. Nominal interest rate was 5%. The government has put a government tax on 30% interest earnings. So, after tax nominal interest rate is less than 5% and remains 3.5%. The other difference is 1.5%. This government takes it in the form of taxes. And if you want to convert this nominal interest rate into real interest rate, then you will minus expected inflation rate from after tax nominal interest rate. Which we assumed is 2%. So, answer will be 1.5%. Okay. Let's look at another scenario. In this, we assume that tax rate has decreased in the government. It has become 20% instead of 30%. What will happen in this case? After tax nominal interest has become 4%. What was nominal interest? 5%. And when tax was 30%, then after tax nominal interest was 3.5%. And after tax nominal interest rate has become 4%. And if you calculate the real interest rate after tax, then the inflation will be minus. So, by minusing it, if 2% inflation has been minused, then it has become 2%. So, what is the point of this? When the government has reduced taxes, then after tax real interest rate has increased. It has become 2% from 1.5%. What will happen if it becomes 2% from 1.5? We can expect that in this case, people are getting a better reward for saving. So, people increase their savings.