The first answer was particularly helpful; ill have a go at my own explanation.
You need to go back to this very basic equation-
Y= C + S
That is, disposable income (income after tax) = Consumption + Savings
Think of Bob the Builder who earns a gross income of $1000 per week. After tax (which he legally has no choice but to pay) he brings in $850 dollars. His DISPOSABLE Income is $850.
He then has two very simple choices- to save it all (i.e. place it in a financial institution such as a credit union, bank, super fund) or to spend it (consume as economists would say). Realistically, he will probably save a fraction and spend a fraction.
The fraction of his disposable income (Y) in which he decides to save (S) is his APS- Average Propensity to Save
Therefore- Amount Saved/Disposable Income or S/Y.
Very simple maths.
Similarly, the amount of disposable income that he uses on consumption (spends) is his Average Propensity to Consume-
Consumption/Disposable Income or C/Y.
The APC and APS are expressed as fractions of Disposable Income- for example 0.3 and 0.7.
As he only has two choices, whether to save or spend, the APC and APS must always sum to give 1.
They vary with individuals, particularly with those of different disposable incomes. Surprisingly, the wealthy has a higher APS and a lower APC compared to the poor. This is because APS/APC are proportional things; poor people will spend a larger amount of their income on bills and just general living expenses leaving little to no room for saving. As you get wealthy, your consumption will rise however you can afford to live comfortably plus have a lot more money left over for savings, hence their APS is higher.
Extending this, economists have come up with the Marginal Propensity (Tendency) to Save/Consume. This looks at the tendency to save/spend each extra dollar of income that is earned.
MPC is the proportion of the next dollar in which someone earns that is spent, and similarly MPS is the proportion that is saved. Eg- I give you one dollar, you spend 80 cents and keep 20 cents, your MPC is 0.8 and your MPS is 0.2. As you can see-
MPC + MPS also add to 1.
As pointed out above, this concept must be clearly understood, as it is the fundamental of Keynes demand theory and the multiplier which you look at to explain economic growth in year 12.
As for the difference between savings and investment. Savings are placed away in a financial institution, the incentive to do so is that they earn interest and hence ‘grow’. If you look at the circular flow of income model (if you haven’t seen this get your teacher to explain it) savings, like taxation and imports are ‘leakages’ from the circular flow as they involve money being taken out of the economic cycle. That is, ceteris paribus if savings increase, the overall level of economic activity decreases as people slow up on consumption (expenditure) which essentially drives production. However, in the long term a reasonable level of domestic savings are important as they allow for investment, usually undertaken by large firms.
Investment is really the creation of capital, placing money in an asset where there is risk, but hopefully the risk is calculated that the overall chance of benefit outweighs cost. Eg- BlueScope steel buying a new $400 million dollar blast furnace is a huge capital outlay. However, over 5 years this may increase their production and sales by 3 billion dollars, clearly showing that the benefit outweighs the cost. Investment is an injection to the economy, and overtime is a clear pathway to economic growth and an expansion of an economies production possibility curve.
Obviously though, investment requires savings as firms need to initially borrow the money. If domestic savings are low, firms may have to look overseas and borrowing from overseas leads to a higher Current Account Deficit which in the long run can place a restrain on economic growth.
As you progress through your economics studies, you’ll see how much things affect one and another. My teacher use to say that in economics there is one answer: everything. For every essay, u can link many concepts and how they all affect each other. At this level though, I wouldn’t stress too much just learn the basic differences and learn you economic models such as the PPC and Circular Flow as they make it so clear within your mind.
Good Luck!
