Chapter 5 - Consumption and Savings

1. CONSUMPTION
&
SAVINGS

2. Economic Income
• Which is earned through economic
activities.
National Income – Reflected in the value of
production.
NI = GNP
Personal Economic Income – which the
firms pay to the households in exchange for
factor contributions.

3. BASIC
CONCEPTS OF
CONSUMPTION

4. Consumption
Household Consumption
• Directly satisfies human wants
Business Consumption
• Indirectly inasmuch as business
activities provide the households
with economic income to meet
consumption expenditures as
periodic payments for society’s
current consumption of social
goods.
It is the act of using goods and services to satisfy human
wants. In a broad sense, it is not the monopoly of households since
businesses and the government also use goods and services to
attain some ends.
Expenditures on Capital Goods – serves as pre-payments of long-run
consumption since durables are gradually consumed and repeatedly used
over a long period.

5. THE
CONSUMPTION
FUNCTION

6. Consumption & Income
• National or Factor Income – its
determinant is Personal or Household
Consumption.
Y = 𝐂𝐛 + 𝚫C
Where:
Y = Factor Income
𝐂𝐛 = Borrowings
from the economy’s
stock of savings
𝚫C = Change in
Consumption
Initially, the economy
dissaves by borrowing from its
stock of savings to meet current
consumption needs in the absence
of income. In realistic terms, this
can mean that poor families spend
more than what they earn by
borrowing from the rest of society
which results in aggregate
consumption that exceeds aggregate
income.

7. The Multiplier Concept
• Multiplier – It is the process of generating income through the
circular flow exchange between the households and the firms.
a) Marginal Propensity to Consume (MPC) – Consumption
Factor
b) Marginal Propensity to Save (MPS) – Savings Factors
• Multiplier Coefficient
It measures the average number of times every peso of inflow
circulates and change hands in the system as income.
It measures the income generated from every peso of inflow
which when multiplied to the total inflow yields aggregate
income.
It depends on the fraction of every additional income
generated in the exchange that flows out of the system as
savings.

8. The Following Equations
Illustrate:
Y = CbM
M =
1
1 −(MPC)
=
1
MPS
MPS + MPC = 1
Where:
M = Multiplier Coefficient
(MPC) = Marginal Propensity to
Consume
MPS = 1 – (MPC) = Marginal
Propensity to Save
S = i
I = Y – ΔC
Y = i + ΔC
M =
𝑌
𝑖
Where:
S = Aggregate savings from
currently generated income
i = Inflow

9. Consumption and Savings
Dissavings/Net Borrowings
Income < Consumption
Net Savings
Income > Consumption

10. Factors of Consumption
Taste or Preference
A. It depends on how the product satisfies one’s desires.
B. A change in collective attitude can change aggregate taste or
preference, consumption, and marginal propensity to consume.
C. Reasons:
a) Duesenberry’s Relative Income Hypothesis – the difference in
consumption behavior could be explained by the difference in
income level relative to what one is accustomed to.
b) It may vary across different racial, ethnic, age, and occupational
groups.
c) Common Mentalities:
1) Gaya – gaya System – One’s consumption is influenced by the
demonstration of others.
2) Colonial Mentality – there is a standing bias for goods marked
“imported” which is also associated to economic status.

11. Population Size – An increase in household size with
income and other factors as constant may decrease the
propensity to consume and increase savings at the expense
of non-essential items in the consumption basket.
Income – Income re-distributed in favor of those with
higher propensity to consume increases the level of
aggregate consumption assuming other factors as constant.
Price Level – Individual product demand is inversely
proportional to price due to the change in purchasing power
and substitution with other products.
Innovation and Promotion – They can expand the line of
consumers’ choice and extend the influence of demand
factors on consumption and propensity to consume income.
Factors of Consumption

12. Engel’s Law and the
Compositional Change in
Consumption Expenditure
Ernest Engel – A German economist in the 19th century who found a
relation between the level of family income and the composition of its
consumption spending.
The Engel’s Law implies that changing the relative importance of
items in the consumption basket depends on how consumers spend
additional income. Spending more of additional income for higher needs
like education increases their share in total consumption and income at
the expense of essential items like food which follows the opposite trend.
ΔCn
Δy
↑ results in
Cn+ΔCn
y+Δy
↑ and
Cn+ΔCn
C+ΔC
↑
At the expense of:
ΔCe
Δy
↓ results in
Ce + ΔCe
y + Δy
↓ and
Ce + ΔCe
C + ΔC
↓
Where:
𝐂𝐧 = Consumption of non-
essential items
𝐂𝐞 = Consumption of
essential items
C = Consumption of all
items
y = Income
𝚫 = Change