10.

Consumption Function
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Definitions
1. Disposable/Net Income: 2. Consumption Function
Expresses consumption spending as a function of disposable income.

YD = YG T = C+ S

10. CONSUMPTION FUNCTION

Torsten Jochem

10. Consumption Function

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10. Consumption Function

The individual Consumption Function
Consumption spending (C)

Consumption
Gross income (Y) can be either consumed (C), saved/ invested (S), or given to the government in taxes (T)
Y=C+S+T

C=YST
No difference to what we did before in GDP chapter! GDP computation by expenditure approach: Y = GDP = C + I + G

The more income you have the more you can save.

Disposable income (DI)

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10. Consumption Function

The individual Consumption Function
Consumption spending (C)

The individual Consumption Function

C=DI

Consumption spending (C)

The more income you have the more you can save.

- Increase in Wealth (= assets liabilities) - Lower interest rates /returns to investment -Expectations, e.g. * higher future income * higher future inflation

dissaving

Break-even

saving

Disposable income (DI)

Disposable income (DI)

10. Consumption Function

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10. Consumption Function

The individual Consumption Function
Consumption spending (C)

The individual Consumption Function

Consumption spending (C)
C2 C1

A shift in disposable income (not wealth!), changes the position along the curve.

- Decrease in Wealth - Higher interest rates /returns to investment - Expectations, e.g. * lower future income * deflation

DI1

DI2

Disposable income (DI)

Disposable income (DI)

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10. Consumption Function

The aggregate Consumption Function
Consumption spending

The aggregate Consumption Function

Consumption spending (C)

C=DI

Autonomous Consumption Level (negative savings)

Note: - the relationship between DI and C is almost 1! - Typical savings rate between 4-10% of income in the U.S.

More aggregate consumption can occur through - a (true or believed) increase of aggregate wealth (e.g. housing prices up, stock market up) - Lower interest rates / investment returns -Expectations for * Higher future inflation * Higher future income
disposable income

dissaving Break-even

saving

Disposable income (DI)

10. Consumption Function

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10. Consumption Function

Consumer Confidence & Consumption

The aggregate Consumption Function

Consumption spending

Less aggregate consumption can occur through - a decrease of aggregate wealth - Higher interest rate / investment returns -Expectations for * deflation * lower future income

disposable income

New Zealand

U.S.

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10. Consumption Function

Marginal Propensity to Consume: Aggregate Case
Consumption spending

Marginal Propensity to Consume (MPC): Individual

How much more do we spend in consumption with one extra dollar of income?
Consumption spending (C) C2 C1

Again, the slope of the (here, aggregate) consumption function is the MPC. Since the aggregate consumption function is virtually linear, we can get the slope from any two points on the line.
disposable income

The slope of the consumption function f(x) for some disposable income x, is called the marginal propensity to consume (MPC) at x.
DI1 DI2 Disposable income (DI)

10. Consumption Function

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10. Consumption Function

Marginal Propensity to Consume: Aggregate Case
Consumption spending

Marginal Propensity to Consume (MPC): Individual

= how much more do we spend in consumption with one extra dollar of income? Example:
Someone earning $x gets a salary increase of $1. Of the increase she spends $0.90 on consumption and saves $0.10. her MPC (at x) = 90% = 0.9 Also, her Marginal Propensity to Save MPS (at x) = 10% = 0.1

C = slope = MPC DI

Note: MPS + MPC = 1

DI

disposable income

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10. Consumption Function

MPC vs. APC
Average Propensity to Consume (APC)
= Total consumption spending/Total disposable income one point on the consumption function is enough.

Example: Given the following graph, whats the MPC?

Consumption spending

$9.975 trill.

APC = C / DI
$9.5 trill

Fraction of consumption in total disposable income

MPC = C / DI
$10 trill. $10.5 trill

disposable income

What we spend on consumption with an increase of disposable income

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10. Consumption Function

The aggregate Consumption Function DI 0 100 200 C 5 100 195 S -5 0 5

Example: Given the following graph, whats the MPC?

Consumption spending

MPC = C / DI
$9.975 trill.

C(DI) = 5 + 0.95 DI
Consumption spending (C) 195

$9.5 trill

MPC = (9.975-9.5) / (10.5 10) = 0.475/.5 = 0.95 MPS = 0.05

100

$10 trill.

$10.5 trill

disposable income

Break even at D.I = C = 100

100

200 Disposable income (DI)

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Any Questions?