When we are saving from our income then we don't consume as mush as we earn. So the GDP should decrease as well as the income but this does not happen. Why?


"GDP" stands for "Gross Domestic Product". It measures the income generated, prior to any consumption-saving allocation. In other words, to be able to save you must first generate product/income and then decide to save. So savings does not affect the level of the already created income, since it is a part of it. The archetypal closed economy with no borrowing is characteriazed by the identity

$$Y = GDP = C + I = C + S$$

When we look the matter from an expenditure approach, we essentially consider the different uses of income (and in that sense the use of the term "expenditure" may be a bit misleading). And savings is also a way to use your income (where "use" has a broader meanign than "spend").

  • $\begingroup$ How is I = S in the above equation ? If we cancel out C(consumption) on both sides. $\endgroup$ – saurav1405 Dec 21 '16 at 15:02
  • $\begingroup$ In the specific archetypal abstract model, savings equal investment by construction. But even if one wanted to consider "hoarding" (i.e. savings that are kept interest-free), it would not alter the fact that GDP creation comes first, allocation decisions after. $\endgroup$ – Alecos Papadopoulos Dec 21 '16 at 15:04
  • $\begingroup$ GDP of the next year should decrease if people save money this year because demand will be less than supply and the extra goods will be stored as inventories hence the firms will produce less next year thus less GDP $\endgroup$ – saurav1405 Dec 21 '16 at 16:56
  • $\begingroup$ @saurav1405 Your comment explicitly introduces an intertemporal aspect which was totally absent from your question. For the new and different question (for which you should open a new thread here and not edit this one), whether savings today will reduce GDP tomorrow, I refer you to the standard (and empirically verified) growth theory. $\endgroup$ – Alecos Papadopoulos Dec 21 '16 at 18:23

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