consumption iimm

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Consumption FunctionConsumption Function



What is GDP?What is GDP?

• Gross Domestic Product (GDP)-Gross Domestic Product (GDP)- is

the nation’s expenditure on all the

final goods and services producedduring the year at market price.

• One way to calculate GDP is by

adding all of Nation’s expenditures.



Nation’s ExpendituresNation’s Expenditures

Consumption

Investment

Government SpendingNet Exports

CC == GDPGDPII+ GG+ NXNX+

This lecture will concentrate on Consumption



ConsumptionConsumption

• Consumption is the nation’s expenditures

on all final goods and services produced

during the year at market prices.

• The total of everyone’s expenditures is

called consumption.

• Consumption is designated by the letter

C.




• C is the largest sector of GDP

• CC is just over two-thirds of GDP

• The consumption functions states :

• As income rises, consumption (C) rises, butnot as quickly

• Therefore, consumption varies with disposable

income (DI)



Aggregate Consumption

• Is the sum total of all expenditure on

current consumption goods and services

which are consumed currently eg. Food,

clothing, fuel, rent etc.

• At low levels of income, almost entire

income is spent on current consumption.

• As income level increases, some income

is kept aside for saving.



• The relation between aggregate

consumption expenditure and aggregate

income of household sector is known as

Consumption Function.

• C = f (Y)



Gross Domestic Saving

• Income not spent on current consumption is

saved.

• In an economy, some consumers may spend

less than their income and some may spend

more than their income.

• Gross Domestic saving is the difference

between GDP and Aggregate Consumption.



Saving Function

• The relation between aggregate saving (S)

and income (Y) is called as Saving

Function.

• Saving function is given as :

• Y = C + S.



Consumption and Disposable

Income

As Income rises so does Consumption

NOT AS QUICKLY!NOT AS QUICKLY!BUT

DIDI increases . . . CC increases but by a smaller

amount

DIDI decreases . . . CC decreases but by a smaller

amount



Two Ways To View Consumption-

Income Relationship

1. As the ratio of total consumption

to total disposable income.

2. As the relationship of changes in consumption to changes in

disposable income.



Average Vs. Marginal

• The average propensity to consume

( APC ) is total consumption in a given

period divided by total disposable income.



Average Propensity toAverage Propensity to

ConsumeConsume

APC = -----------------------------------Consumption

Disposable Income



Disposable Income Consumption Saving

Rs.40,000 Rs.30,000




Rs.40,000 Rs.30,000 Rs.10,000

APC = ------------ = ------------ = ------ = .75 C 30000 3

DI 40000 4




Rs.40,000 Rs.30,000 Rs.10,000

APC = ------------ = ------------ = ------ = .75 C 30000 3

DI 40000 4

APS = ------------ = ------------ = ------ = .25 S 10000 1

DI 40000 4




Rs.40,000 Rs.30,000 Rs.10,000

APC = ------------ = ------------ = ------ = .75 C 30000 3

DI 40000 4

APS = ------------ = ------------ = ------ = .25 S 10000 1

DI 40000 4

+

1.00



Disposable Income Saving

Rs.20,000 Rs.1,500




Rs.20,000 Rs.1,500

Disposable Income Saving Consumption

Rs.20,000 Rs.1,500 Rs.18,500




Rs.20,000 Rs.1,500


Rs.20,000 Rs.1,500 Rs.18,500

APC = ------------ = ------------ = ------ = .925C 18500 37

DI 20000 40




Rs.20,000 Rs.1,500


Rs.20,000 Rs.1,500 Rs.18,500

APC = ------------ = ------------ = ------ = .925C 18500 37

DI 20000 40

APS = ------------ = ------------ = ------ = .075 S 1500 3

DI 20000 40




Rs.20,000 Rs.1,500


Rs.20,000 Rs.1,500 Rs.18,500

APC = ------------ = ------------ = ------ = .925C 18500 37

DI 20000 40

APS = ------------ = ------------ = ------ = .075 S 1500 3

DI 20000 40

+

1.00



APCs Greater than One


Rs.10,000 Rs.12,000





Rs.10,000 Rs.12,000 - 2000

APC = ------------ = ------------ = ------ = 1.2C Rs.12,000 12

DI Rs.10,000 10





Rs.10,000 Rs.12,000 - 2000

APC = ------------ = ------------ = ------ = 1.2C Rs.12,000 12

DI Rs.10,000 10

APS = ------------ = ------------ = ------ = -0.2S -Rs.2,000 -2

DI Rs.10,000 10





Rs.10,000 Rs.12,000 - 2000

APC = ------------ = ------------ = ------ = 1.2C Rs.12,000 12

DI Rs.10,000 10

APS = ------------ = ------------ = ------ = -0.2S -Rs.2,000 -2

DI Rs.10,000 10

+

1.00



The Marginal Propensity to

Consume• The marginal propensity to consume

(MPC ) is the fraction of each additional

(marginal) rupee of disposable income

spent on consumption.



Marginal Propensity

to Consume (MPC)

MPC =in Consumption

in Income

CHANGE CHANGE

CHANGE CHANGE



Marginal Propensity

to Consume (MPC)

Year DI C S

1998 Rs.30000 Rs.23000 Rs.7000

1999 Rs.40000 Rs.31000 Rs.9000



Marginal Propensity

to Consume (MPC)

Year DI C S

1998 Rs.30000 Rs.23000 Rs.7000

1999 Rs.40000 Rs.31000 Rs.9000

10000 8000 2000Change



Year DI C S

1998 Rs.30000 Rs.23000 Rs.7000

1999 Rs.40000 Rs.31000 Rs.9000

10000 8000 2000Change

MPC =---------------- = ---------- = ------- = .8Change in C 8000 8

Change in DI 10000 10



Year DI C S

1998 Rs.30000 Rs.23000 Rs.7000

1999 Rs.40000 Rs.31000 Rs.9000

10000 8000 2000Change

MPC =---------------- = ---------- = ------- = .8Change in C 8000 8


MPS = -------------- = ---------- = -------- = .2Change in S 2000 2


+

1.0

Graphing Consumption Function



45

Rs.1000

Rs.1000

Rs.6000

?Rs.6000

Consumption

& Saving

Disposable Income

Graphing Consumption Function

G hi th C ti F ti



Graphing the Consumption Function

If Consumption rose at the same rate as Disposable

Income . . . A graph of this function would be a 45 line

Disposable income ($)

45û

1,000

1,000

2,000

3,000

2,000 3,000

Expenditur

e(Rs. )

Disposable Income (Rs.)



C

Rs.6000

5700

Rs.6000

Saving = Rs.300

Rs.2700

Rs.3000

Dissaving = Rs.300

Rs.2700

Saving = - Rs.300

Disposable Income



C

Dissaving

Saving

Disposable Income





Consumption is the vertical distance between the

bottom (horizontal) axis and the “C” line.

DI C S

3000 1750


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Expen

ditur

e(Rs.)






DI C S

3000 1750 1250


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Saving is the vertical distance between the “C” line and

the 45 degree line

Expenditur

e(Rs. )






DI C S

3000 1750 1250

2000 1440


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Consumption is the vertical distance between the bottom

(horizontal) axis and the “C” line.





DI C S

3000 1750 1250

2000 1440 560


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Saving is the vertical distance between the “C” line and the

45 degree line

Expen

ditur

e(Rs.)





DI C S

3000 1750 1250

2000 1440 560

1000 1000


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Consumption is the vertical distance between the bottom

(horizontal) axis and the “C” line.





DI C S

3000 1750 1250

2000 1440 560

1000 1000 0


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Saving is “0” at 1000 DI because there is NO distance between the

C line and the 45 degree line.




DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

When DI is “0” the level of Consumption is called

Autonomous Consumption (AC)





DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625-625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

Saving is the vertical distance between the “C” line and the 45 degree

line. Saving is negative to the left of where the C line crosses the 45

degree line



Autonomous Consumption

versus Induced Consumption

• Autonomous means Self Governing

• Autonomous consumption (AC) isthe level of consumption whendisposable income is “0”

–It is called autonomous becauseit is independent of change indisposable income



Induced Consumption

• Induced consumption (IC) is that partof consumption which varies with the

level of disposable income

– As disposable income rises, inducedconsumption rises

– As disposable income fall, induced

consumption falls



C

Rs.0

This is your This is your

AutonomousAutonomous


Disposable Income

Graphing the Consumption



Graphing the Consumption

Function

DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625-625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

DI = 0

What is IC?

IC = C - AC

IC = 625 - 625

IC = 0





DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625-625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

DI = 1000

What is IC?

IC = C - AC

IC = 1000 - 625

IC = 375





DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625-625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

DI = 2000

What is IC?

IC = C - AC

IC = 1440 - 625

IC = 815





DI C S

3000 1750 1250

2000 1440 560

1000 1000 0

0 625-625


45û

C

1,000 2,000 3,0001,000

1,000

2,000

3,000

DI = 3000

What is IC?

IC = C - AC

IC = 1750 - 625

IC = 1125



Consumption & Saving Function

Consumption Function

Saving Function

a

0 y’

45 o

C = a + bY

-a

Consumption

C

Saving

S

0

Saving

Where a = autonomous & b = MPC

When Y = 0, C = a So, 0 = a + S i.e S = -a

Y = C + S

When Y = Y’, C = Y’, S = 0 So, Y’ = Y’ + S i.e. S = 0

Y = C + S

Y = (a + bY) + S

Y – (a + bY) = S

Y – a – bY = S

-a + Y – bY = S

-a + Y( 1 - b) = S (1-b) = MPS

Disposable Income



Determinants of ConsumptionDeterminants of Consumption

1. Disposable Income

The most important determinant

of consumption

1. Credit Availability

2. Stock of Liquid Assets in the hands

of consumers

3. Stock of Durable Goods4. Keeping up with the neighbors..

5. Consumer Expectations

The Determinants of



The Determinants of

Saving• There is no single reason why people

save

• Some spend virtually all of their

disposable income

• Some spend more than they earn

• Americans now save less than 5% of

disposable income

consumption iimm

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