What determines the allocation of output between consumption and investment according to the text?

The allocation of output between consumption and investment is fundamentally linked to the saving rate, designated as "s." When households decide how much of their income to consume versus how much to save, this saving rate directly influences the availability of funds for investment. A higher saving rate implies that a larger proportion of output is being saved rather than consumed, providing more resources for investment in capital goods, which is essential for long-term economic growth.

In economic models, such as the Solow growth model, this relationship is crucial. It suggests that as the saving rate increases, more capital can be accumulated, ultimately leading to higher levels of output and productivity in the economy. Conversely, a lower saving rate means less investment, which can restrict growth potential and future output.

Understanding this relationship helps clarify why the saving rate is a pivotal factor in determining how an economy distributes its resources between immediate consumption needs and longer-term investments in productivity. This allocation is vital for sustaining economic growth and improving standards of living over time. Other factors like the interest rate, tax rates, and government policies can influence these decisions but do so indirectly or as a result of the fundamental relationship established by the saving rate.