• Consumption is one of the major components of the economy’s gross national product. • Traditionally, consumption was an unimportant element in economics as compared to production and political economic issues. • However, with the development of a consumer society that resulted to an increased consumed power in the market place, it was recognized as a central activity to modern life. The Concept of Consumption • In economics, consumption refers to the using up of resources. It is the money spent on goods and services which yield satisfaction. • In Keynesian economics, it is the “shorthand” for personal consumption expenditure and it is determined by the consumption function. • But how do we relate it with saving? • Actually, the idea is simple: the part of income which is not consumed is saving. Expressed mathematically, The Concept of Consumption • In economics, consumption refers to the using up of resources. It is the money spent on goods and services which yield satisfaction. • In Keynesian economics, it is the “shorthand” for personal consumption expenditure and it is determined by the consumption function. • But how do we relate it with saving? • Actually, the idea is simple: the part of income which is not consumed is saving. Expressed mathematically, The Consumption Function • The consumption function tells us the relationship between consumption level and the level of household disposable income. Determinants of Consumption • Consumption has a directly proportional relationship with income; that is, consumption spending increases as income increases. Consumption depends on other things aside from income, and these are wealth, price level, consumer’s expectation, and interest rate. Determinants of Consumption 1. Wealth. It is the value of an asset owned, less the liabilities a household owed. To increase wealth, one must augment saving or pay off debt. Since an important reason for saving is to increase one’s wealth, the larger the wealth, there is less incentive to save and consumption will increase. 2. Price Level. A rising price level reduces the purchasing power of households; therefore, savings will fall. As a result, households will reduce their consumption and increase their savings. 3. Consumer’s Expectation. If a consumer expects that his income will increase in the future, he will increase his consumption today. An anticipation of an increase will encourage higher consumption today as well. 4. Interest Rate. If interest rate falls, there will be less incentive for savers to keep their money in securities. In response to this, savers will just increase their consumption. Determinants of Consumption Marginal Propensity to Consume (MPC) Marginal Propensity to Save (MPS) Average Propensity to Consume (APC) Average Propensity to Save (APS) Determinants of Consumption Determinants of Consumption The Multiplier Effect • The multiplier principle states that an increase in autonomous spending will cause national output to increase by a multiple of the initial increase in spending. Aggregate Consumption Expenditure Model