Consumption

Consumption is a major concept in economics and is also studied by many other social sciences.
Economists are particularly interested in the relationship between consumption and income, and
therefore in economics the consumption function plays a major role.
Different schools of economists define production and consumption differently. According to
mainstream economists, only the final purchase of goods and services by individuals constitutes
consumption, while other types of expenditure in particular, fixed investment, intermediate
consumption, and government spending are placed in separate categories (See consumer
choice). Other economists define consumption much more broadly, as the aggregate of all
economic activity that does not entail the design, production and marketing of goods and
services

Behavioral Economics and Consumption

The Keynesian consumption function is also known as the absolute income hypothesis, as it only
bases consumption on current income and ignores potential future income (or lack of). Criticism
of this assumption lead to the development of Milton Friedman's permanent income hypothesis
and Franco Modigliani's life cycle hypothesis. More recent theoretical approaches are based on
behavioral economics and suggest that a number of behavioral principles can be taken as
microeconomic foundations for a behaviorally-based aggregate consumption function.
Consumption and Household Production
Consumption is defined in part by comparison to production. In the tradition of the Columbia
School of Household Economics also known as the New Home Economics commercial
consumption has to be analyzed in the context of household production. Opportunity cost of time
affects the cost of home-produced substitutes and therefore demand for commercial goods and
services. The elasticity of demand for consumption goods is also a function of who performs
chores in households and how their spouses compensate them for opportunity costs of home
production
Different schools of economists define production and consumption differently. According to
mainstream economists, only the final purchase of goods and services by individuals constitutes
consumption, while other types of expenditure in particular, fixed investment, intermediate
consumption, and government spending are placed in separate categories (See consumer
choice). Other economists define consumption much more broadly, as the aggregate of all
economic activity that does not entail the design, production and marketing of goods and
services (e.g. the selection, adoption, use, disposal and recycling of goods and services).

Consumption can also be measured by a variety of different ways such as energy in energy
economics metrics.
Our prehistoric ancestors spent much of their waking hours foraging for and consuming food, an
instinct that obviously paid off. Today this instinct is no less powerful, but for billions of us its
satisfied in the minutes it takes to swing by the store and pop a meal in the microwave. With our
physical needs sated and time on our hands, increasingly were finding psychological outlets for
this drive, by seeking out and consuming concepts.
Conceptual consumption strongly influences physical consumption. Keeping up with the Joneses
is an obvious example. The SUV in the driveway is only partly about the need for transport; the
concept consumed is status. Dozens of studies tease out the many ways in which concepts
influence peoples consumption, independent of the physical thing being consumed. Here are just
three of the classes of conceptual consumption that we and others have identified.
Consuming expectations.
Peoples expectation about the value of what theyre consuming profoundly affects their
experience. We know that people have favorite beverage brands, for instance, but in blind taste
tests they frequently cant tell one from another: The value that marketers attach to the brand,
rather than the drinks flavor, is often what truly adds to the taste experience. Recent brainimaging studies show that when people believe theyre drinking expensive wine, their reward
circuitry is more active than when they think theyre drinking cheap wineeven when the wines
are identical. Similarly, when people believe theyre taking cheap painkillers, they experience
less relief than when they take the same but higher-priced pills.
Consuming goals.
Pursuing a goal can be a powerful trigger for consumption. At a convenience store where the
average purchase was $4, researchers gave some customers coupons that offered $1 off any
purchase of $6, and others coupons that offered $1 off any purchase of at least $2. Customers
who received the coupon that required a $6 purchase increased their spending in an effort to
receive their dollar off; more interestingly, those customers who received the coupon that
required only a $2 purchase to receive the dollar off actually decreased their spending from their
typical $4, though of course they would have received their dollar off had they spent $4.
Consuming the specific goal implied by the couponreceiving a savings on a purchase of a
designated amounttrumped peoples initial inclinations. Customers who received the $2
coupon left the store with fewer items than they had intended to buy.
Consuming memories.
One study of how memories influence consumption explored the phenomenon whereby people
who have truly enjoyed an experience, such as a special evening out, sometimes prefer not to
repeat it. We might expect that they would want to experience such an evening again; but by

forgoing repeat visits, they are preserving their ability to consume the pure memorythe
conceptof that evening forever, without the risk of polluting it with a less-special evening.
So concepts not only can influence people to consume more physical stuff, but also can
encourage them to consume less. Offering people a chance to trade undesirable physical
consumption for conceptual consumption is one way to help them make wiser choices. In
Sacramento, for example, if people use less energy than their neighbors, they get a smiley face
on their utility bill (or two if theyre really good)a tactic that has reduced energy use in the
district and is now being employed in Chicago, Seattle, and eight other cities. In this case, people
forgo energy consumption in order to consume the concept of being greener than their neighbors.
We suggest that examining peoples motivations through the lens of conceptual consumption can
help policy makers, marketers, and managers craft incentives to drive desired behaviorfor
better or for worse.

The Importance of Consumption

Every time you purchase food at the drive-thru or pull out your debit or credit card to buy
something, you are adding to consumption. Consumption is one of the bigger concepts in
economics and is extremely important because it helps determine the growth and success of the
economy. Businesses can open up and offer all kinds of great products, but if we don't purchase
or consume their products, they won't stay in business very long! If they don't stay in business,
many of us won't have jobs and the income to buy goods and services.
Definition
Consumption can be defined in different ways, but is usually best described as the final
purchase of goods and services by individuals. The purchase of a new pair of shoes, a hamburger
at the fast food restaurant, or the service of getting your house cleaned are all examples of
consumption. It is also often referred to as consumer spending. Many topics in economics
explore how the income of families and individuals affects consumption and spending habits.

Theories
There are many different theories on income and consumption behavior, and we will focus on
some of the more mainstream concepts in consumption theory.

Keynesian Theory and Real Income

One of the most popular and well-known theories is the Keynesian theory (offered by John
Maynard Keynes). This theory states that current real income is the most important determinant
of consumption in the short run. Simply said, you spend according to how much income you
have coming in. This is the basis for most consumption theory.
The term 'real' that is used in describing income refers to how your income is affected by
inflation, or the natural rise in prices of goods and services. So to elaborate, if your income went
up 5% in a year, but the price of goods or inflation went up 5% also, your real income remained
flat. You can't really buy or consume any more goods than you could before.
States Affecting Consumption
So what else do economists believe affects consumption and your decision to purchase products
and services, besides your real income?

Prices - If prices are higher, then a person's total level of consumption will be lower,
because consuming will use up a higher percentage of a person's income.

Taxes - As taxes on goods and services (sales taxes) rise, people may not be able to afford
as much as they used to and as a result will consume less. The income tax rates you pay
also affect your ability and decision to consume. Higher tax rates lead to less disposable
income, which is money you have left over for spending and savings after you pay taxes.

Saving - People generally have two things they can do with their money. They can save
or they can spend. The more money people save, the less they have to consume in the
short-run.

Consumer Confidence - If people are worried about the economy or their own future
income, they may delay making purchases in order to provide some safety and extra cash
for future expenses. They will save or delay their consumption until they feel better about
what lies ahead.

Meaning of Consumption and their Classification

By consumption we mean the satisfaction of our want by the use of commodities and services.
When we use a commodity, we really use its want satisfying quality of utility. For example when
we take a glass of water to quench our thirst we are said to consume water. When we are sitting
on chair in the office, we are consuming the chairs. A person is sick, he calls in a Doctor, and he
has consumed the Doctors services. Thus, taking a glass of water means it is actual consumption
of water but in case of chair and Doctors Services, consumption refer to utilization of chair of
Doctors services, consumption refer to utilization of chair of Doctors services.
Therefore consumption can be defined as.

1. To make use of any commodity of service for the satisfaction of our wants is called
consumption.
2. Consumption means destruction of utility.
Types of consumption:
Consumption is known as Direct of Final consumption when the goods satisfy human wants
directly and immediately. E.g. taking of meals, use of furniture. On the other hand, consumption
is called indirect or productive consumption when the goods are not meant for final consumption
but for producing other goods which will satisfy human wants, e.g. use of fertilizer in
agriculture.

Importance of Consumption:
1. The consumption is very importance as it is the beginning as well as the end of all
economic activities. A man feels desire and then the makes an effort to satisfy it when the
effort has been made the result is the satisfaction of the want. Thus want is the beginning
and satisfaction the end of our economic activity.
2. The production, as an economic activity depends upon consumption. Producer is taking
production of a certain good because it is going to be consumed by the consumer.
Therefore consumption determines the production.
3. The intensity of consumption of particular goods determines the price in a market. Thus
consumption also influences the exchange activity. The existence of exchange in an
economy is due to consumption only.
4. Distribution, i.e. sharing of incomes to landlords, capitalist labour and organizer is also
influenced by consumption. Consumption indicates standard of living and standard of
living determines the efficiency. Efficiency determines the share in the national income
The 3 types of news consumption & how they differ
Talking Points Memo
The general manager of personalized news aggregator News.me, Jake Levine, lays out his theory
of three distinct types of news consumption, each with a different community and pattern:

Theres world news or national news, which people usually get from large publishers like the
New York Times or CNN. The typical behavior here is a daily headline scan and the occasional
deep dive into one or two stories of interest. The community at play here is your city, your
democracy, your world.
Then theres a type of news that is more specific to a persons interests ESPN.com for
sports, Mediagazer for media, Techmeme / Hacker News for technology, for example. With
this type of news you want to be aware of the major stories throughout the day, and will likely
jump into a few of articles for the full story.
Then theres highly personalized news. This requires the most significant effort from the user.
With this type of news, youre aware of all of the days major stories, and likely reading with
the intent of sharing back out to the people you care about. You read the news as a means to
participate in the community thats most important to you.
I asked Levine to elaborate by email. He cited data on how often News.me subscribers open their
daily email news digest and then which stories they click on. The digest contains the first and
third types of news as defined above a handful of editors-choice top stories, and a handful of
the best stories shared by friends.
The first type, general-interest top news, draws mixed interest from News.me
subscribers. Adding top world and national news to the News.me daily digest created a big boost
in the number of people who bothered to open the emails (Hey, thats interesting!), but
incredibly low click-through rates on the headlines (but not that interesting).
What we learned, Levine told me, is that people have a desire to be made aware of these big
big stories, but most dont really want to read them. A headline and 1-2 sentences is enough.
The personalized type of news (filtered based on what a users Twitter or Facebook friends have
shared) is much more engaging, Levine said, with more than 30 percent of readers clicking on at
least one headline link.
Personal Consumption Expenditures (PCE), or the PCE price index, is a statistic compiled
and released quarterly by the U.S. Bureau of Economic Analysis (BEA) that synthesizes a host of
data, chief among them the U.S. Producer and Consumer Price indices.
How it works/Example:
The PCE price index measures the price fluctuations and related consumer behavior for all
domestic consumption of durable and non-durable goods and services targeted toward
individuals and households. The PCE "core index", however, excludes the more volatile
components of food and energy.

Personal consumption is divided into two key categories: goods and services. The category of
"goods" is further broken down into "durable" goods, which are big-ticket items (refrigerators,
television sets, cars, mobile phones, etc.) that will last more than three years, and "non-durable"
goods that are more transitory (e.g., cosmetics, fuel, clothing, etc.).
Why it Matters:
PCE not only measures underlying inflationary pressures, it also reflects whether the consumer is
doing his or her part to propel economic growth.
Because three-fourths of Gross Domestic Product (GDP) is consumer spending, the PCE report
is a useful tool for investors to analyze the overall state and direction of the economy.
For more on the PCE and GDP, read: Understanding Economic Indicators: Gross Domestic
Product.

what households, not businesses, do. This involves expenditure on goods and services, such as
petrol, shopping and a new fridge. However, consumption can be split down further into durable
and non-durable purchases.

Durable purchases are those that are going to last a long time - often years! These include
items like cars, cookers, and televisions. Fridges, cookers, washing machines etc. are all
durable goods.

Non-durable purchases are those that only last for a short period of time and are 'used up'.
A good example of this is going to the shops to buy food and drink.

1) Cost of Credit
If credit becomes difficult, mainly through expense of interest rates, some households may
postpone their credit financed purchases. There will be a reduction in consumption until
circumstances change, i.e. accumulate more savings, or a fall in interest rates
2) Assets
Most households appear to have target levels of assets/wealth at each stage of their life cycle. If
assets fall unexpectedly, households will increase their saving and reduce consumption. This
works in reverse for situations like a sudden increase in wealth.
3) Disposable Income
Disposable income (income is often expressed as 'Y') is income after taxes. It is the amount of
total income that can be spent with reasonable freedom by the household. Thus, disposable
income is total income minus taxes (and sometimes also regarded as including other fixed

payments, such as mortgage repayments). It is that income which can be 'disposed of' with near
freedom.
4) Expectations
Individuals' attitudes to the functionality of the economy effects the level of aggregate
expenditure. For example, households increase purchases of consumer durables if they believe
interest rates will remain low or job security improves, etc. Expectations are the source of both
business and household economic indicators. Strictly speaking, an expectation is a leading
economic indicator, since it predicts changes in an economy and changes occur before
corresponding changes in the economy.
A leading indicator is an economic statistic that suggests transactions in the future. For
example, building permits suggest construction activity in the near term, and hence the hiring of
construction workers and purchases of building materials. Purchases of raw materials by
manufacturing industries ordinarily suggest a level of likely production. Increases in either
suggest increased activity; decreases suggest decreases in near-term activity. Stock prices fit this
category because high prices for corporate stocks create the impression of wealth that spurs
consumption.
A coinciding indicator ordinarily indicates activity at the time. It is often a defining
characteristic of the economy such as payroll or sales volume.
A lagging indicator is a statistic that ordinarily follows economic changes. Unemployment rates
are a prime example; decisions by most employers to hire workers follow increases in activity
and the parallel decision to lay off workers follows decreases in activity.
5) Taxation
A change in the level of taxation on income (income tax) will reduce the amount of disposable
income available. Because of this, C could fall. However, if an equal or greater sum were given
out in benefits to households, particularly to unemployed, then consumption could even rise. It is
important to note that an increase in taxation will not necessarily cause a contraction in
consumption. Further, if taxation and benefits were used to redistribute income/wealth from
richer to poorer households, consumption might rise. This is because less wealthy households are
more likely to spend a greater proportion of their disposable income than extremely rich
individuals.
1) Cost of Credit
If credit becomes difficult, mainly through expense of interest rates, some households may
postpone their credit financed purchases. There will be a reduction in consumption until
circumstances change, i.e. accumulate more savings, or a fall in interest rates

2) Assets
Most households appear to have target levels of assets/wealth at each stage of their life cycle. If
assets fall unexpectedly, households will increase their saving and reduce consumption. This
works in reverse for situations like a sudden increase in wealth.
3) Disposable Income
Disposable income (income is often expressed as 'Y') is income after taxes. It is the amount of
total income that can be spent with reasonable freedom by the household. Thus, disposable
income is total income minus taxes (and sometimes also regarded as including other fixed
payments, such as mortgage repayments). It is that income which can be 'disposed of' with near
freedom.
4) Expectations
Individuals' attitudes to the functionality of the economy effects the level of aggregate
expenditure. For example, households increase purchases of consumer durables if they believe
interest rates will remain low or job security improves, etc. Expectations are the source of both
business and household economic indicators. Strictly speaking, an expectation is a leading
economic indicator, since it predicts changes in an economy and changes occur before
corresponding changes in the economy.
A leading indicator is an economic statistic that suggests transactions in the future. For
example, building permits suggest construction activity in the near term, and hence the hiring of
construction workers and purchases of building materials. Purchases of raw materials by
manufacturing industries ordinarily suggest a level of likely production. Increases in either
suggest increased activity; decreases suggest decreases in near-term activity. Stock prices fit this
category because high prices for corporate stocks create the impression of wealth that spurs
consumption.
A coinciding indicator ordinarily indicates activity at the time. It is often a defining
characteristic of the economy such as payroll or sales volume.
A lagging indicator is a statistic that ordinarily follows economic changes. Unemployment rates
are a prime example; decisions by most employers to hire workers follow increases in activity
and the parallel decision to lay off workers follows decreases in activity.
5) Taxation
A change in the level of taxation on income (income tax) will reduce the amount of
disposable income available. Because of this, C could fall. However, if an equal or greater
sum were given out in benefits to households, particularly to unemployed, then
consumption could even rise. It is important to note that an increase in taxation will not

necessarily cause a contraction in consumption. Further, if taxation and benefits were used
to redistribute income/wealth from richer to poorer households, consumption might rise.
This is because less wealthy households are more likely to spend a greater proportion of
their disposable income than extremely rich individuals.

Consumption varies between about 40-60% of total expenditure depending on what type
of economy you are in, and the period in the economic cycle it is currently at.

Consumption Function: Meaning, determinants and importance.

Consumption, in economics, the use of goods and services by households. Consumption is
distinct from consumption expenditure, which is the purchase of goods and services for use by
households. Consumption differs from consumption expenditure primarily because durable
goods, such as automobiles, generate an expenditure mainly in the period when they are
purchased, but they generate consumption services (for example, an automobile provides
transportation services) until they are replaced or scrapped.
CONSUMPTION FUNCTION:
A mathematical relation between consumption and income by the household sector. The
consumption function can be stated as an equation, usually a simple linear equation, or as a
diagram designated as the consumption line. This function captures the consumption-income
relation that forms one of the key building blocks for Keynesian economics. The two key
parameters of the consumption function are the intercept term, which indicates autonomous
consumption, and the slope, which is the marginal propensity to consume and indicates induced
consumption. Aggregate expenditures used in Keynesian economics are derived by adding
investment, government purchases, and net exports to the consumption function.
The consumption function is the starting point in the Keynesian economics analysis of
equilibrium output determination. It captures the fundamental psychological law put forth by
John Maynard Keynes that consumption expenditures by the household sector depend on income
and than only a portion of additional income is used for consumption.This function is presented
either as a mathematical equation, most often as a simple linear equation, or as the graphical
consumption line. In either form, consumption is measured by consumption expenditures and
income is measured as disposable income, national income, or occasionally gross domestic
product.
The primary purpose of the consumption function the basic consumption-income relation for the
household sector, which is the foundation of the aggregate expenditures line used in Keynesian
economics.

The consumption function makes it easy to divide consumption into two basic types.
Autonomous consumption is the intercept term. Induced consumption is the slope. Of no small
importance, the slope of the consumption function is also the marginal propensity to consume
(MPC).
First, The Equation
The consumption function can represented in a general form as:
C

f(Y)

where: C is consumption expenditures, Y is income (national or disposable), and f is the notation

for a generic, unspecified functional form.Depending on the analysis, the actual functional form
of the equation can be linear, with a constant slope, or curvilinear, with a changing slope. The
most common form is linear, such as the one presented here:
C

bY

where: C is consumption expenditures, Y is income (national or disposable), a is the intercept,

and b is the slope.The two key parameters that characterize the consumption function are slope
and intercept.

Slope: The slope of the consumption function (b) measures the change in consumption
resulting from a change in income. If income changes by $1, then consumption changes
by $b. This slope is generally assumed and empirically documented to be greater than
zero, but less than one (0 < b < 1). It is conceptually identified as induced consumption
and the marginal propensity to consume (MPC).

Intercept: The intercept of the consumption function (a) measures the amount of
consumption undertaken if income is zero. If income is zero, then consumption is $a. The
intercept is generally assumed and empirically documented to be positive (0 < a). It is
conceptually identified as autonomous consumption.

Consumption Line

Then, The Graph

The consumption function is also commonly presented as a diagram or consumption line, such as
the one presented in the exhibit to the right. This red line, labeled C in the exhibit is positively
sloped, indicating that greater levels of income generate greater consumption expenditures by the
household sector. The specific consumption function illustrated in this exhibit is:
C

0.75Y

For reference, a black 45-degree line is also presented in this exhibit. Because this line has a
slope of one, it indicates the relative slope of the consumption line.
The two primary characteristics of the consumption function--slope and intercept--also can be
identified with the consumption line.

Slope: The slope of the consumption line presented here is positive, but less than one. In
this case the slope is equal to 0.75. Click the [Slope] button to highlight.

Intercept: The consumption line intersects the vertical axis at a positive value of $1
trillion. Click the [Intercept] button to highlight.

And Other Factors

The consumption function captures the relation between consumption and income. However,
income is not the only factor influencing consumption.
C

f(Y, OF)

where: C is consumption expenditures, Y is income (national or disposable), and now OF is

specified as other factors affecting consumption. These other factors, officially referred to as
consumption expenditures determinants, include a range of influences. Some of the more notable
consumption determinants are consumer confidence, interest rates, and wealth.Consumer
confidence is the general optimism or pessimism the household sector has about the state of the

economy. More optimism means more consumption. Interest rates affect the cost of borrowing
the funds used to purchase durable goods. Higher interest rates mean less consumption. Wealth is
the financial and physical assets owned by the household sector. More financial wealth means
more consumption, while more physical assets mean less consumption.These determinants cause
consumption expenditures to change even though income does not change. Or another way of
stating this, determinants cause consumption expenditures to change at every level of income.
For a linear consumption function, this change is reflected by a change in the intercept term (a).
For a consumption line, the change is seen as an upward or downward shift.
Determinants Of The Consumption Function Or Propensity To Consume
There are a number of factors both subjective and objective which determine the position of
consumption function. The factors or causes of shifts in consumption function are as fellows.
(I) Subjective Factors:
(i) Psychological characteristics of human nature:
The subjective factors affecting propensity to consume are internal to the economic system. The
subjective factors include characteristics human nature: The subjective factors affecting
propensity to consume are internal to the economic system. The subjective factors include
characteristics of human nature, social practices which lead households to refrain or activate to
spending out of their incomes. For example, religious belief of the people towards spending,
their foresight, attitude towards life, level of education, etc. etc., directly affect propensity to
consume or determine the slope and position of the consumptions curve. The subjective factors
do not undergo a material change over a short period of time. These remain constant in the short
run.
(II) Objective Factors:
The objective factors are external to economic system. They undergo rapid changes and bring
market shifts in the consumption function. The main objective factors are as under:
(1) Level of Real Income.
Level of real income is the-basic factor which determines communitys
propensity to consume. When real income of the community increases, consumption expenditure
also increases but by a Smaller amount. The consumption function shifts upward.
(2) Distribution of Wealth:
If there is unequal distribution of wealth in a country, the consumption
function will also be unequal. People with low income group have high propensity to consume
and rich people low propensity to consume. An equal distribution of wealth raises the propensity
to consume.
(3) Expectation of Changes in Price.
If people expect that prices are going to rise in near future, they
hasten to spend large sum out of a given income in order to get benefit of low prices. That is

what actually, happened just after the promulgation of first Martial Law in our country. So we
can say that when priCes are expected to be high in future, the propensity to consume increases
or the consumption function shifts upward. When they are expected to be low, the propensity to
consume decreases or the consumption function shifts downward. .
(4) Changes in Fiscal Policy: Taxes also play an important part in influencing the propensity to
consume. If the nature of taxes is such that they directly affect the poor people and redUce their
incomes, then the propensity to consume is high and if rich persons are not taxed at a progressive
rate and they accumulate more wealth, then the propensity to consume is low.
(5) Changes in the Rate of Interest: A change in the rate of interest exercises influence on the
propensity to consume. When the interest rate is raised, it generally induces people to decrease
expenditure and save more for lending purposes, On the other hand, when the interest rate is
reduced, it usually encourages expenditure as lending then becomes less attractive. So we
conclude that an increase in the rate of interest generally reduces propensity to consume or
shifts ,the consumption function downward and a fall in the rate of interest usually helps to the
increase of propensity to. consume or shifts the consumption function upward.
(6), Availability of Goods:
Propensity to consume is also affected by the availability of
consumption goods. If the goods are available in abundance, then the propensity to consume
increases. If they are scarce and are priced very high, then the propensity to consume will
decline.
(7) Credit Facilities: If cheap credit facilities are available in the country, the consumption
function will move upward.
(8) Higher Living Standard:
If the real income of the people increases inthe country and people adopt the
use of new products like television, washing machines, refrigerators, cars, etc., etc., the
consumption function is high.
(9) Stock of Liquid Assets:
If the consumers have greater amounts of liquid assets, there will be more
desire for the households to spend out of disposable income. The consumption function shifts
upward and vice versa.
(10)
Consumer Indebtedness:
In case the consumers are heavily indebted and they pay bigger
monthly installments to repay the debt, then propensityto consume is low or the consumption
function shifts downward and vice versa.
11) Windfall gains:
If there are unexpected gains due to stock market boom in the economy, it
tends to shift the consumption function upward. They are windfall gains.
The unexpected losses in the stock market lead to the downward shifting of the consumption
curve.
(12) Demographic factors:
The consumption function is also influenced by demographic factors like

size of family, occupations, place of residence etc. Persons living in cities, for instance, spend
more than those living in rural areas.
(13) Attitude towards saving:
If a community is consumption oriented, there will be less saving in the
country. The consumption function shifts upward. In case, people save more and spend less, then
the consumption function will shift downward.
(14) Demonstration effect.
If people are easily influenced by advertisements on radio and television
and seeing pattern of living of the rich neighbours, the level of total consumption will go up.
How to raise the propensity to consume: The propensity to consume can be raised by (1)
transferring wealth from rich to the poor (2) increased wages (3) provision of cheap end easy
credit facilities (4) Advertisements (5) Development of means of transport (6) Urbanization and
through advertisement.
Concept Of Propensity To Save Or Saving Function
The propensity to save schedule which for the sake of brevity is called the propensity to save
shows relation between saving and disposable income at varying levels of incomes S = F(Y). The
propensity to save schedule comes from subtracting, consumption from income at each level of
income. Since saving represents the difference between the 450 guideline and the consumption
function, it may be positive or negative. The propensity to save schedule can easily be
derived:from the propensity to consume schedule, in our example given earlier, the propensity to
consume is as follows:Income

Rs. (billion) 50,

Expenditure Rs. (billion)

50,

100,

140,

200

300

70,

100,

140,

200

The propensity to save schedule can easily be derived by subtracting the amount of consumption
from the corresponding amount of income. The saving schedule thus is as follows:Income

Rs. (billion)

50,

100,

140,

200

300

Save

Rs. (billion)

0,

30,

40,

60,

100

Concepts of propensity to save.

There are two concepts of propensity to save:
(i) Average propensity to save. (ii) Marginal propensity to save.
(i) Average propensity to save: Average propensity to save is the percentage of income
saved at a given level of income (APS). The average propensity to save at any point can be
found by dividing saving by income. For instance, if the disposable income is Rs. 100 billion and
expenditure Rs. 80 billion on consumption goods, then the saving win be equal to Rs. 20 billion.
The average propensity to save will be = .2. The average propensity to save .can also be found by
subtracting average propensity to consume from 1. In the above example, the average propensity

to consume is
80
- .8. So the average propensity to save will be 1 .8 = .2
1000
(ii) Marginal Propensity to save: Marginal propensity to save is the ratio of change in
saving to change in income. The MPS measures the change in saving
generated by a change in income.
MPS Change in saving
Change in income
It is also found out by substracting marginal propensity to consume form I. Thus MPS
= I MPC. The concepts of propensity to save and marginal propensity to save are
illustrated below:
Importance of the Consumption Function
Importance of the Consumption function Consumption function is not to be considered merely a
subject of study and analysis. It has a great theoretical and practical importance. All countries
want to remove unemployment from their midst, raise their national income and enjoy
prosperity. For this purpose a policy of planned economic development is essential. In the
formulation of this policy, consumption function plays a very useful role.
Consumption function is not to be considered merely a subject of study and analysis. It has a
great theoretical and practical importance. All countries want to remove unemployment from
their midst, raise their national income and enjoy prosperity. For this purpose a policy of planned
economic development is essential. In the formulation of this policy, consumption function plays
a very useful role.
We briefly discuss below the importance of
consumption from various points of view:
1. Important Tool of Macro-economic Analysis.
Consumption function is an important tool of macro-economic
analysis given to us by Keynes. Without the consumption function, we would not have been able
to find a determinate link between changes in investment and the resultant changes in income of
a country. From this point of view, for the macro-economic theory, the consumption function is
as important a tool as the demand and supply functions is in the theory of firm and the industry.
2. The Value of the Multiplier.
From the consumption function, we derive the value of the multiplier,
which as we have known are equal to1/ 1-mpc. Here MPC is marginal propensity to consume.

Since marginal propensity to consume is less than unity, an initial injection of purchasing power
into the income stream leads to a multiple expansion of total income in a peculiar way. That is,
original' injection of money into the economy leads to several successive increments of income
in the course of responding 10 the increase in original purchasing power. The multiplier gives us
a quantitative link between changes in investment and changes in income. If, for example, the
marginal propensity to consume is f, we know that the multiplier will be 4 so that if investment
increases by say, Rs.-1,000, national income will rise by Rs.-4,000. Even before Keynes, the
economists knew that changes in investment bring about changes in income but by how much
and through which process was not clear, till Keynes gave us tools of consumption function and
the multiplier
.3. Invalidates Say's Law.
Consumption function helps to invalidate Say's Law which said that supply
creates its own demand. Since marginal propensity to consume is less than unity, the whole of
the income is not spent on the output produced. According to Say's Law, general over-production
in the country is not possible since supply is supposed to create its own demand. This law may
hold good in the long run, but not in the short run. In the long run, the market forces establish
equilibrium automatically so that demand may be equated to
supply. But no such automatic adjustment is possible in the short run. Hence, for some time there
may occur general overproduction. According to Say's Law, an act of producing is
simultaneously an act of creating proportional effective demand. There is no doubt production
creates value equal to itself but that value is not wholly spent then and there. Since marginal
propensity to consume is less than unity, the classical law of markets does not hold good,
because the entire output cannot be taken off the market or the entire income is not spent. We
knew that marginal propensity to consume is less than unity, i.e., as income increases,
consumption increases less than increase in income. Hence, supply, far from creating its own
demand, exceeds demand and creates a glut in the market which means general overproduction
and mass unemployment.
4. Shows Crucial Importance of Investment.
Consumption function also underlines the crucial importance of
investment. Because propensity to consume is stable, employment can be created only by
increasing investment. Consumption function tells us that people spend proportionately less than
the increase in their income. Therefore, it becomes necessary to fill the gap between income and
consumption by increasing investment; otherwise it will not be profitable to increase output and
employment. We also know that consumption function is more or less stable. Hence, it is
instability of investment which is responsible for fluctuations in income and employment in a
country. It is, therefore, clear that investment plays a vital role in increasing income and
employment in a country. If propensity of consumption could also increase, income and
employment could be increased even without increasing investment. But, since consumption
function is stable, investment is the crucial and initiating determinant of the levels of income and
employment.

5. Explains the Declining Marginal Efficiency of Capital.

Consumption function explains the declining
marginal efficiency of capital. Since consumption function does not increase which could raise
the level of consumption expenditure, the prospective yield of capital assets falls. Once the
demand for capital goods decreases, the marginal productivity of capital cannot rise unless the
marginal propensity to consume rises. Thus, the fall in the marginal productivity could be
checked, if the marginal propensity to consume could be increased. Hence, the marginal
efficiency tends to decline because the demand for goods is discouraged on account of the
marginal propensity to consume not rising or the marginal propensity to save not falling. It is the
stability of the marginal propensity to consume which explains the declining marginal efficiency
of capital.
6. Explain the Turning Points of the Business Cycle.
Consumption the turning points of the business cycle. The
trade cycle takes the downward course because the marginal propensity to consume is less than
unity, i.e the people do not spend proportionately more as their income increases similarly, the
consumption function explains the upturn of the business cycle. This is due to the fact that since
consumption is stable, people are unable to cut down their consumption expenditure to the full
extent of a decrease in their income. It shows the danger of permanent over-saving gap and thus
explains the secular decline in the marginal efficiency of capital.
Thus, consumption function occupies a very important place in the theory of employment.

What are the Variants of Consumption Function?

By Pragati Ghosh
Different types of Consumption Function are listed below:
1. Short-Run Consumption Function:
In short run, consumption expenditure is not a simple proportion of income. It is not zero when
income is zero. In other words, a consumer has to incur some expenditure on consumption even
when his income is zero.
This expenditure, known as the subsistence or autonomous consumption (Ca), is must for every
individual to meet the minimum basic needs irrespective of the level of income enjoyed.
Expenditure incurred on consumption over and above Ca bears a proportional relationship with
the disposable income (Yd). A typical consumption function of this type is referred to as a nonproportional consumption function and is given as:

C = Ca + b.Yd
Where, C = consumption expenditure,
Ca = autonomous consumption expenditure,
b = a positive constant,
Yd = consumers disposable income, which is equal to the excess of income over Net Direct
Taxes (direct taxes less transfer payments). [Direct taxes (T) refer to personal taxes such as
income tax paid and transfer payments (R) refer to unilateral transactions such as old-age
pensions received by the individuals. Net Direct Taxes are thus equal to T-R.] = Y (T R)
= Income consumers feel free to dispose off any way they like.
Graphically, the relationship in equation (4.1) is portrayed as in Figure 4.1. Disposable Income
Yd is measured on horizontal axis and consumption expenditure (C) on vertical axis. When Yd is
zero, C is Ca. In a two sector model, disposable income, Yd = Y, as tax and transfer payments are
nonexistent due to absence of government sector.
The graph is a straight line with an intercept on the vertical axis. For the consumption function in
question. Average Propensity to Consume (APC) can be defined as the consumption expenditure
incurred per unit of income, i.e.,
APC = Consumption expenditure (C) / Income (Y)

Thus, APC = b, when Y =; and APC > b, when Y has finite values. In general, APC b
In like manner. Marginal Propensity to Consume (MPC), defined as an increase in the
consumption expenditure per unit increase in income of the consumers, can be expressed as
MPC = Increase in consumption expenditure (C) / Increase in income (Y)
= C / Y or dC / dY
MPC can thus be obtained for this consumption function through simple differentiation of C with
respect to Y.
MPC = dC / dY
=0+b
=b

Alternatively, let initial and final levels of consumption be C1 and C2 at income levels of Yl and
Y2 respectively. Then,
C1 = Ca + bY1 and
C2 = Ca + bY2
Subtracting,
C2 - C1 = b (Y2 Y1)
C = b Y
C / Y = b
= MPC.
For this consumption function, therefore,
APC MPC. (From equations 4.2 and 4.3)
2. Long-Run Consumption Function or Proportional Consumption Function:
In the long run, consumption expenditure is proportional to the income of the consumers. It may
be given as:
C = bY
Consumption expenditure, in this case, is zero when income is zero. Average and marginal
propensities can be shown to be identical for this type of consumption function.
APC = C/Y
= bY / Y = b
In like manner,
MPC = C / Y = b
The autonomous consumption (Ca) in this case is zero. This type of consumption function relates
to the long-run tendency of consumption expenditure (Fig. 4.2).

3. Non-Linear Consumption Function:

This type of consumption function is quasi-linear (partly linear and partly non-linear). It
represents pattern of consumption in advanced countries or of affluent sections. The algebraic
expression may take the following form:

C = Ca+ bY + cY2
None of the APC and MPC is constant. Each one is a function of income. For instance,
APC = Ca/Y + b + cY
MPC = b + 2cY
MPC is a linear function of Y while APC is a parabolic function of it. Fig. 4.3 portrays the nature
of the curve represented by equation 4.7.
Consumption Function
AAA |
DEFINITION of 'Consumption Function'
The consumption function is a mathematical formula laid out by famed economist John Maynard
Keynes. The formula was designed to show the relationship between real disposable income and
consumer spending, the latter variable being what Keynes considered the most important
determinant of short-term demand in an economy.
The consumption function is represented as:

Where:
C = Consumer spending
A = Autonomous consumption, or the level of consumption that would still exist even if income
was $0
M = Marginal propensity to consume, which is the ratio of consumption changes to income
changes
D = Real disposable income
'Consumption Function'
The consumption function is shown here to be linear, but that is dependent on the variable "M"
(marginal propensity to consume) staying the same. In fact, consumers tend to spend a smaller
percentage of their disposable income as it rises, creating a curved effect at higher income levels.
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consumption, in economics, the use of goods and services by households. Consumption is
distinct from consumption expenditure, which is the purchase of goods and services for use by
households. Consumption differs from consumption expenditure primarily because durable
goods, such as automobiles, generate an expenditure mainly in the period when they are
purchased, but they generate consumption services (for example, an automobile provides
transportation services) until they are replaced or scrapped. (See consumer good.)
Neoclassical (mainstream) economists generally consider consumption to be the final purpose of
economic activity, and thus the level of consumption per person is viewed as a ... (100 of 2,643
words)
Consumption and the business cycle
Private consumption expenditure accounts for about two-thirds of gross domestic product (GDP)
in most developed countries, with the remaining one-third accounted for by business and
government expenditures and net exports. A substantial portion of government expenditure (e.g.,
spending on public health programs) is also considered to be consumption expenditure, as it
provides a service that consumers value.

In national income accounting, private consumption expenditure is divided into three broad
categories: expenditures for services, for durable goods, and for nondurable goods. Durable
goods are generally defined as those whose expected lifetime is greater than three years, ... (100
of 2,643 words)
INTRODUCTION
Spending money to tout one's success is not a now phenomenon. The desire to conspicuously
consume dates back to tribal times when men possessed women and slaves as trophies of their
status (Vablen 1912). Since that time, although the players and what is consumed have changed,
the game of ostentatious ownership has remained essentially the same, with the winners being
awarded status, prestige and honor. Early in the game, only the aristocratic elite could play. Yet
as societies became industrialized, players of achieved wealth, or the nouveau rich, followed by
those of moderate and even negligible success entered the game. Some argue that flagrant
consumptive behavior is the unfortunate result of capitalism (Veblen 1912, Marx 1848 Galbraith
1984, Toynbee 1973, Stanfield and Stanfield 1980), while others note that material ownership
helps us to define who we are (Goffman 1952, Belk 1988, Solomon 1983, McCracken 1987,
Levy 1959).
McCracken (1987) notes that "conspicuous and competitive consumption are especially
important to the study of the history of consumption because they play such an important role in
the growth of a consumer society' (p. 50). Further, he suggests that by studying overt displays of
wealth both between and within social groups, we may better understand what has propelled
Western societies headlong into their present preoccupation with material possessions.
The purpose of this paper is to demonstrate how modern American conspicuous consumption has
developed through time and over societies. First, three theories of conspicuous consumption are
briefly reviewed. Then, a periodization scheme is used to explain and compare traditional,
achieving, affluent (Mason 1981) and post-affluent societies as they relate to conspicuous
consumption. Finally, an analysis of marketing's response to conspicuous consumption along
with discussion of some more recent explanations of this unique consumption behavior are
incorporated in this presentation.
THEORETICAL BACKGROUND
Several themes have boon proposed as to why people feel the need to conspicuously consume.
The earliest of which was put forth by Thorstein Veblen in his book The Theory of the Leisure
Class, first published in 1899. According to Veblen (1912), the strength of one's reputation is in
direct relationship to the amount of money possessed and displayed; i.e., the basis "of gaining
and retaining a good name, are leisure and conspicuous consumption" (p. a4). He theorizes that
"pecuniary strength" confers not only "invidious distinction', but also honor, prestige, and esteem

within the community. To Veblen, lavish spending was "symptomatic of the superfluous life-style
of the rich. Wearing diamond-studded jewelry and overindulging in luxurious foods and
alcohol ... were prerequisites of men of gentle breeding" whose lavish spending "redounded to
their glory" (Diggins 1978, p.17). Above all, as Veblen notes, the objects of conspicuous
consumption must be wasteful, or possess no useful value, in order to reflect credibly on one's
reputation (1912, pp. 97-8).
Modernized Vablen's work, Duesenberry (1967) developed his own theory which he labeled the
"demonstration" or 'bandwagon' effect. In essence, this effect is an attempt to "keep up with the
Joneses" in order to preserve one's self-esteem (McCormick 1983). A reverse theory of the
bandwagon effect, also expressive of modern day consumptive behavior, is the 'snob" effect
(Mason, 1981). This theory states that people preoccupied with social status reject products that
are perceived to be possessed by the common populace. Thus, the 'snob" consumer seeks to
purchase products which have limited availability. This type of exclusive consumption
guarantees a measure of social prestige (Mason 1981, p.128).
Think Consumption Is The 'Engine' Of Our Economy?
Have you heard that the economy is like a car? Its the most popular analogy in financial
reporting and political discourse. The American people are repeatedly told by financial pundits
and politicians that consumption is an engine that drives economic growth because it makes
up 70% of GDP. One notable Nobel-winning economics pundit with a penchant for bizarre
growth theories even recently noted that an economy can be based on purchases of yachts,
luxury cars, and the services of personal trainers and celebrity chefs. Conversely, other
economists including Nobel-winner Joseph Stiglitz claim that our economy is stuck in first
gear due to inequality: too much income is concentrated among too few rich people who tend to
save larger share of their income and thus have a lower marginal propensity to consume. The
Keynesian message is clear: if you want to put the economic pedal to the metal, get out there and
consume!
Not so fast, Speed Racer. The systematic failure by Keynesian economists and pundits to
distinguish between consuming and producing value is the single most damaging fallacy in
popular economic thinking. This past Christmas, we produced a playful video called Deck the
Halls with Macro Follies exploring the history of this popular myth. If the economy were a car,
consumer preferences would surely be the steering wheel, but real savings and investment would
be the engine that drives it forward.
A History of Macro Follies
The historical record on economic growth conflicts with this consumption doctrine. Economic
growth (booms) and declines (bust) have always been led by changes in business and durable

goods investment, while final consumer goods spending has been relatively stable through the
business cycle. Booms and busts in financial markets, heavy industry and housing have always
been leading indicators of recession and recovery. The dot-com boom and bust, the Great
Depression and our current crisis all exhibit the pattern.
For example, during our past two decades of booms and busts, investment collapsed first,
bringing employment down with it. Consumption spending actually increased throughout the
2001 recession (financed, in part, by artificially easy credit) even as employment was falling
along with investment. During our continuing crisis, consumption spending returned to its alltime high in 2011yet investment to this day remains at decade lows, producing the worst
recovery in growth and employment since the Great Depression. Labor force participation hasnt
been this low since the 1980s. But why?
As John Stuart Mill put it two centuries ago, the demand for commodities is not the demand for
labor. Consumer demand does not necessarily translate into increased employment. Thats
because consumers dont employ people. Businesses do. Since new hires are a risky and costly
investment with unknown future returns, employers must rely on their expectations about the
future and weigh those decision very carefully. As economic historian Robert Higgs pioneering
work on the Great Depression suggests, increased uncertainty can depress job growth even in the
face of booming consumption. As recent years have demonstrated, consumer demand that
appears to be driven by temporary or unsustainable policies is unlikely to induce businesses to
hire.
The past several decades in America have been marked by a collapse of real savings encouraged
by artificially easy credit from the Fed, along with explosive growth in government spending. All
these combined to bring about a debt-fueled spending binge, with disastrous consequences.
Increased investment drives economic growth, while retrenched investment leads to recession
and reduced employmentand it always has. Those who blame our stagnation on a lack of
consumer demand rely on a toxic brew of dubious data and dangerous theory.
Before I Can Consume, I Must Produce for Others
By definition, GDP is a summary of final sales for new goods and services and not of all
economic activity. Raw materials, intermediate goods and labor costs, which comprise the bulk
of business spending are not treated in GDP, but are rather rolled up in the final sale price of the
consumer spending. Only capital equipment, net inventory changes and purchase of newly
constructed homes constitute investment according to GDP. This framing of the data makes the
consumption drives the economy a foregone conclusion. But this is circular reasoning.

Where do these consumers get their money to spend? Before we can consume, we need to
produce and earn a paycheck. And paychecks have to flow to productive that is value-creating
behavior, or value is simply being transferred and destroyed. Our various demands as
consumers are enabled by our supply as workers/producers for others. Thats the classical Law
of Markets, often referred to as Says Law, in a nutshell.
For employees, those paychecks are income, but for the employers, wages represent most
business single largest expense. Yet GDP does not treat employee wages or materials as
investment spending even though any business owner regards salaries as the most important
and largest investment that they make. Instead, employee wages appear in GDP data as
consumption when income is spent on final goods like food, clothing, gadgets, and vacations.
Moreover, since GDP is an accounting summary, it adds consumption and investment spending
together. But this summarizing masks the fact that these two activities are actually in opposition
in the short run. In order to invest more today, we have to save more and consume less. As a
result, GDP in-and-of-itself reveals nothing about what grows an economy; at best, it
demonstrates how large the economy is and whether its growing or shrinking.
Digging below the surface of GDP reveals a structure of value-adding production far more
complex than the simplistic analysis given by most media reports. According to government
data, more than 70% of Americans earn their incomes from employment in domestic business.
Yet the retail sector of our economy, for example, only contributed 6% of GDP. Bureau of Labor
Statistics (BLS) data on employment show that only about 11% of employed Americans work in
sales and related occupations. That leaves a great deal of economic activity and employment
to the business to business sector, which composes most of the real economy.
Most of the value-adding activities occurred between a vast structure of businesses and workers
starting with raw materials and blueprints and coming together over months (sometimes years
when R&D is included) before a final sale can be made. At each stage, the activity is funded not
by current consumer spending but through a combination of new investment and savings such
as each companys reinvested earnings. The farther from a final good a businesss output is, the
more it relies on credit markets and the more it is subject to distortions on the savings and
investment side. And since employment is spread across this time structure with relatively few
working in final retail stage, savings and investment changes have dramatic impacts on
employment.
Organic Growth
My wife Lisa and I have personal experience with dynamics that the top-down Keynesian view
ignores. Several years ago we launched a side-business designing, manufacturing and selling
reusable all-in-one cloth diapers to moms interested in saving money and cutting down on trash.
We called them weehuggers.

To start the business, we got a small capital contribution from my brother-in-law in exchange for
equity in the company. These savings were put to use buying the raw materials, designing the
diaper prints, hiring sets of skilled people both to sew the diapers and to build the website.
Designing, testing and producing the product and website took over a year. Almost none of that
activity was included in GDP for that year, except through the consumer spending of people
we paid. Throughout this stage, no product existed for others to demand or for us to sell and
generate income. The time Lisa and I spent building the company was also a very real form of
investment itself. This so-called sweat equity is just as much of an investment as a financial
contribution.