What is 'Capital Saturation '

Capital saturation occurs in an economy when real income is high and is expected to continue to rise, which in turn causes the general public, corporations and even public entities to concentrate on consumption rather than on saving. This combination can lead to a stronger economy, but it could eventually lead to an economic bubble.

BREAKING DOWN 'Capital Saturation '

Capital saturation is driven in part by a sizable level of real income, which refers to one’s income after taking into consideration the effects of inflation on purchasing power. For example, if you receive a 4 percent salary increase over the previous year and inflation for the year is 2 percent, then your real income increases by 2 percent. A backdrop of low inflation can accelerate capital saturation, because it leaves more spending money in the hands of consumers and businesses alike.

More frequently, though, capital saturation is associated with a low interest rate environment. Low rates tend to encourage spending and discourage saving. Instead of earning low yields on savings accounts or fixed-income investments, for example, many consumers will choose to splurge on higher ticket items, while companies increase their capital expenditures and seek to create more jobs.

While this may sound like an ideal backdrop in which to live and work, capital saturation can ultimately result in a large-scale problem. Given its influence, capital saturation could spark an economic boom that eventually reaches a state of euphoria, causing the economy to become fully dependent on the current conditions of prosperity. If the elevated levels of consumption are reduced too harshly or too swiftly, perhaps due to an economic shock or increase in interest rates, a large number of businesses will be left with excess capacity in their facilities. At the same time, consumers could find themselves overextended on credit. A shift away from this bubble-type of economy may eventually result in a bust, like such historic example as the Great Depression in the 1930s or the Great Recession of 2008–2009.

The Acceleration Principle of Capital Consumption

The acceleration principle is an economic concept that draws a connection between the rate of change of consumption and capital investment. According to the acceleration principle, if demand for consumer goods increases, then the percentage change in the demand for machines and other investment necessary to make these goods will increase even more. In other words, if income and therefore consumption increases, there will be a corresponding but magnified change in investment. It is important to note that this principle does not compute the rate of change in capital investment as a product of the overall level of consumption, but as a product of the rate of change in the level of consumption.

RELATED TERMS
  1. Consumption Tax

    A consumption tax is a tax on the purchase of a good or service. ...
  2. Income Effect

    The income effect is the change in demand for a good or service ...
  3. Autonomous Consumption

    Autonomous consumption is the minimum level of consumption that ...
  4. Savings Rate

    Savings rate is the percentage of money take from personal income ...
  5. National Savings Rate

    An estimate known as the national savings rate gauges the amount ...
  6. Capital

    Capital is a term for financial assets or their financial value, ...
Related Articles
  1. Investing

    Consumer Confidence: A Killer Statistic

    The consumer confidence is key to any market economy, so investors need to learn how to analyze them.
  2. Investing

    What is the Income Effect?

    In economics, the income effect is the change in the consumption of goods caused by a change in income, whether income goes up or down.
  3. Insights

    How Can Emerging Markets Avoid The Middle-Income Trap?

    Emerging markets all reach a point when rapid growth stops. We look at ways to avoid this and move to the next level.
  4. Insights

    What's the Economy?

    The economy is the production and consumption activities that determine how scarce resources are allocated in an area.
  5. Financial Advisor

    Implications of the Federal Reserve's Impending Rate Hike

    The Federal Reserve begins its two-day meeting on Wednesday, September 16, and everyone is watching to see if the central bank will raise the United States target interest rate for the first ...
  6. Investing

    India as Fastest-Growing Big Country: Don't Buy It

    In January 2015, India changed the method it uses to calculate GDP, shifting the base from the year that ended March 2005 (fiscal 2005) to fiscal 2012 and using a benchmark based on gross value ...
  7. Insights

    How Interest Rates Affect The U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds and inflation.
  8. Personal Finance

    How Savings Are Saving The Economy

    Even with inflation fears, saving money is still sage advice in a recovering economy.
  9. Trading

    3 factors that drive the U.S. dollar

    We look at three important factors that affect U.S. dollar value, and how to determine when it's the right time to buy currency.
RELATED FAQS
  1. What is the difference between financial capital and economic capital?

    Read about the differences between types of financial capital, which companies use to raise money, and economic capital models ... Read Answer >>
  2. What is the difference between capital gains and investment income?

    Learn about the difference between capital gains and other types of investment income, such as dividends paid on stock or ... Read Answer >>
  3. Which factors drive the marginal propensity to consume?

    Discover the main factors of economic policy that, according to Keynesian economic theory, drive the marginal propensity ... Read Answer >>
  4. Are Social Security payments included in the US GDP calculation?

    Understand how gross domestic product is calculated and whether or not transfer payments such as Social Security are included ... Read Answer >>
  5. How can a change in fiscal policy have a multiplier effect on the economy?

    Learn about how changes in fiscal policy have a multiplier effect on the economy. The goal of expansionary fiscal policy ... Read Answer >>
  6. What causes inflation, and does anyone gain from it?

    In this article, we will examine the fundamental factors behind inflation, different types of inflation and who benefits ... Read Answer >>
Trading Center