Discuss the Economic Relationship Between Consumption, National Income and Investment

Discuss the economic relationships between consumption, national income and investment.

Aggregate demand is heavily determined by the state of consumption, the spending on consumer goods and service over a period of time; Furthermore income and investment have a very volatile connection with consumption. National income is the total level of output of a country and is calculated by C+I+G+(X-M)= AD however there is three ways in which we can be interpreted. Firstly The expenditure method is the worth of household spending of goods and services, secondly national output is the amount flowing between goods and services from firms to households; finally there is the national income which is the value of income to households from land, capital and labour from firms. The three components must be identical not just equal. Investment is the expenditure on capital goods, that then are used to provide other goods or services. Investment can be effected by the accelerator effect as an increase in nation income results in an increase in investment, however for this theory to take place its not the rate of interest that determines the level of investment but real spending within the economy.

Consumption influences national income as it has many determinate’s, however it is important to determine that income is a flow ands wealth is a stock. National income is strongly controlled by confidence as the higher the confidence people feel, the more they will spend. Confidence can be knocked by unexpected events, such as in a recession or a fall in the housing market or stocks leaving people feeling there wealth is worth less and and then reseed on consumption, this is known as the wealth effect. An increase in national income could occur due to consumption benefiting from tax cuts, as there will therefore be more to consume due to a higher disposable income available. Another way would be cutting interest rates making loans cheaper therefore again leading to more consumption. The government spending more on public sector salaries e.g. teachers and nurses would increase national income as consumption would see an increase. Finally The housing market is a very conclusive factor to determine the state of national income. If houses increase in value there is a larger amount of equity available this can lead to people using equity withdrawal to consume more and the wealth effect takes place here also.