Consumption Function
The consumption function in economics refers to the relationship between disposable income and consumer spending. It is a key concept in understanding how changes in income affect consumption patterns. The function typically shows that as income increases, consumption also increases, but at a diminishing rate.
6 Key excerpts on "Consumption Function"
eBook - ePubFoundations of Macroeconomics
Its Theory and Policy
- Frederick S. Brooman(Author)
- 2017(Publication Date)
- Routledge(Publisher)
...Different functions may be preferred, depending on the structure of the broader framework of the macroeconomic analysis of which they form a part. In any case, statistical information is lacking in most countries about many variables with a good claim to be included on a priori grounds. Certainly, no function is generally accepted as the Consumption Function for the United States in the 1960’s and 1970’s. What is generally agreed, however, is that the dependence of consumption on current income is sufficiently great in the short run to justify the use of such a relationship in theoretical analysis; if this can be taken for granted, certain results follow with regard to the equilibrium of the economy as a whole, and the next chapter will be devoted to a consideration of them. _______________ 1 See pp. 51 – 54. 2 Keynes originally called it “the propensity to consume” (General Theory, p. 90), but subsequent usage has established the term “Consumption Function” in its place. Following the notation introduced earlier (p. 69), consumption as a function of income is expressed as C – C(Y). 3 It is the Δ that makes the MPC marginal. C/Y can be called the average propensity to consume – the proportion of all income that is spent on consumption. 4 This statement, of course, assumes appropriate definitions of income and consumption. See above, pp. 54 – 55. 5 For a more rigorous account of the logic of this choice, see G. Ackley, Macroeconomic Theory (New York: Macmillan, 1961), pp. 249-251. 6 The individual will still be devoting a larger proportion of his total income to consumption than to sparing. If he had to choose between consuming all his income and sparing all of it, he would choose consumption, because the satisfaction given by the, say, 50th dollar of consumption (when no sparing is done) must be greater than that from the 50th dollar spared (when no consumption is taking place)...
eBook - ePubHousehold Finance
A Functional Approach
- Sumit Agarwal, Wenlan Qian, Ruth Tan(Authors)
- 2020(Publication Date)
- Palgrave Macmillan(Publisher)
...In this view, households save and hence consume as a function of the interest rate (Bunting 2001). Keynes observed that “(t)here are not many people who will alter their way of living because the rate of interest has fallen from 5 to 4 percent” (Keynes 1936). His “fundamental psychological law” of consumption was proposed in his General Theory. The fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income. Keynes postulated that households consume more goods and services as their absolute income increases. Thus, the Keynesian Consumption Function is also known as the absolute income hypothesis. A basic tenet of the Keynesian Consumption Function is that households determine the proportion of income that is devoted to consumption based on the absolute level of income. In the Keynesian model, the Consumption Function is an increasing function of disposable income (See Fig. 3.1). As disposable income rises, consumer spending will increase. The classic Keynesian Consumption Function assumes that household spending is wholly determined by current income and changes in income. Fig. 3.1 Keynesian Consumption Function According to the absolute income hypothesis, consumption is based on present disposable income as represented by the following equation where C is consumption, Y d is disposable income and b is the marginal propensity to consume (MPC): Households’ average propensity to consume (APC) declines as the level of income increases. APC is the proportion of income that is devoted to consumption. At low income, households will spend a higher proportion of their income. The APC can be one, which means households spend all their income, or greater than one...
eBook - ePub- Milton Friedman(Author)
- 2020(Publication Date)
- Dover Publications(Publisher)
...The term is generally used in statistical studies to designate actual expenditures on goods and services. It therefore differs from the value of services it is planned to consume on two counts: first, because of additions to or subtractions from the stock of consumer goods, second, because of divergencies between plans and their realization. Let us use the terms “permanent income” and “permanent consumption” to refer to the concepts relevant to the theoretical analysis, so as to avoid confusion with the frequent usage of income as synonymous with current receipts and consumption as synonymous with current expenditures, and let us designate them by y p and c p respectively, with an additional numerical subscript to denote the year in question. 6 We can write the Consumption Function as since y p1 = iW 1. This approach seems somewhat forced for the present simple case of a horizon of only two years. Initial wealth is then spent on consumption during the two years, rather than being maintained. It makes much more sense if (2.4) is regarded as a generalization from this special case to a longer horizon. 7 The only empirical restrictions that have been imposed on the indifference curves up to this point are that they be negatively sloped (to be consistent with the observed absence of a tendency for individuals to give their wealth away indiscriminately) and convex to the origin (to be consistent with the observed absence of a tendency for individuals to spend their entire wealth on consumption in a single time period). These restrictions on the indifference curves impose only rather mild restrictions on the shape of a Consumption Function described by (2.2) or (2.4). To get a more specific hypothesis about the shape of the Consumption Function we shall have to go farther. Suppose money prices are the same in the two years so that a point on the 45 degree line OD in Figure 1 represents equal opportunities in the two years...
eBook - ePubEconomics After the Crisis
An Introduction to Economics from a Pluralist and Global Perspective
- Irene van Staveren(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...So, although the propensities to consume decline with rising income, the absolute amounts spent on consumption will generally not go down. This is because consumers with higher incomes tend to shift to the more luxury segments of a product category. For food, this means prepared food from the supermarket, exotic food from the delicatessen shop, and eating out in restaurants. Diagram 3.2 Engel curve The propensity to consume (c) can be written in the following equation as the share of income (Y) going to consumption (C): C = cY The propensity to save (s) is its complement, namely the proportion of income saved (S): S = sY Together, income is distributed over consumption and savings: Y = C + S In other words: y = cY + sY So, if income is 1,000 roubles and the propensity to consume is 0.8, then total consumption is 0.8 × 1,000 = 800 roubles. And, because Y = C + S, we can derive that total savings is 200 roubles, which is Y − C. This is 1,000 − 800 = 200. Finally, it follows that the propensity to save is 0.2, because S = sY, so 200 = 0.2 × 1,000. And also because the sum of the propensity to consume and the propensity to save is 1 (if we disregard borrowing, using the ceteris paribus assumption): c + s = 1 Hence, if c = 0.8 and c + s = 1, then it follows that s = 1 − 0.8 = 0.2. 3.5 Neoclassical theory of consumption 3.5.1 Individual and market demand In a purely material way, demand for a particular consumer good depends on its price level and the available budget. We tend to buy more of a good when it is cheap and when we have more income, and less of a good when it is expensive and when we have less income. This is the case for normal goods, the standard case in neoclassical economics. This results in a negative relationship between price (P) and quantity (Q), as Diagram 3.3 shows. When prices are high, quantities demanded are low, and the other way around. The result is a straight downward sloping demand curve (D 1) for, say, healthy meals bought per month...
eBook - ePub- Anthony J. Makin(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...The mpc indicates how much extra consumption stems from an incremental change in income, and is a fraction lying between zero and unity. Graphically, the Keynesian Consumption Function (see Figure 4.1) shows that current period consumption is determined by current period income. The slope of the Keynesian Consumption Function is the mpc. Empirical evidence of the validity of this relationship is mixed however, suggesting that it fails to fully explain private consumption behaviour. The life cycle hypothesis Contrary to the prediction of the Keynesian approach, the ratio of private consumption to national income tends to be stable over the long run, as conveyed by the long-run relationship in Figure 4.1. This fact inspires the life cycle hypothesis (LCH) of consumption proposed by Nobel laureate Franco Modigliani. According to this perspective, individuals are not solely concerned about what happens today but are forward looking and think about what happens in the future. The LCH proposes that saving allows individuals to transfer income over the course of their entire lives. In turn, this permits consumption levels, and hence living standards, to be maintained at a certain level throughout life. Maintaining a stable level of consumption is referred to as consumption smoothing. FIGURE 4.1 Keynesian and long-run Consumption Functions FIGURE 4.2 Income, consumption and saving over the life cycle Consider the case of those who save through their working lives for retirement. As shown in Figure 4.2, if the individual saves during the working years, wealth (the stock value of accumulated saving) continues to rise until retirement begins. Thereafter, in retirement, the individual lives off (decumulates) lifetime saving by drawing on wealth or lifetime saving. Running down past saving is also known as dissaving. The permanent income hypothesis The permanent income hypothesis (PIH) is a third theory of consumption and saving that is closely related to the LCH...
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...Section 3 introduces utility theory, a building block of consumer choice theory that provides a quantitative model for a consumer’s preferences and tastes. Section 4 surveys budget constraints and opportunity sets. Section 5 covers the determination of the consumer’s bundle of goods and how that may change in response to changes in income and prices. Section 6 examines substitution and income effects for different types of goods. A summary and practice problems conclude the chapter. 2. CONSUMER THEORY: FROM PREFERENCES TO DEMAND FUNCTIONS The introduction to demand and supply analysis in the previous chapter basically assumed that the demand function exists, and focused on understanding its various characteristics and manifestations. In this chapter, we address the foundations of demand and supply analysis and seek to understand the sources of consumer demand through the theory of the consumer, also known as consumer choice theory. Consumer choice theory can be defined as the branch of microeconomics that relates consumer demand curves to consumer preferences. Consumer choice theory begins with a fundamental model of how consumer preferences and tastes might be represented. It explores consumers’ willingness to trade off between two goods (or two baskets of goods), both of which the consumer finds beneficial. Consumer choice theory then recognizes that to consume a set of goods and services, consumers must purchase them at given market prices and with a limited income. In effect, consumer choice theory first models what the consumer would like to consume, and then it examines what the consumer can consume with limited income. Finally, by superimposing what the consumer would like to do onto what the consumer can do, we arrive at a model of what the consumer would do under various circumstances...
