Macroeconomics two concepts are explained briefly in this slide. Consumption and Investment function and related concepts viz., multiplier, accelerator and business cycles

1. Macroeconomics: Consumption and Investment
Function
• Consumption Function and Investment
Function: Introduction, Consumption
Function, Investment Function, Marginal
efficiency of capital and business
expectations, Multiplier, Accelerator.
• Business Cycle: Introduction, Meaning and
Features, Theories of Business Cycles,
Measures to Control Business Cycles,
Business Cycles and Business Decisions.

2. Prepared by Dr. Samita Mahapatra 2
HOUSEHOLD
SECTOR
FIRMS
Land, Labour, Capital, Organization
Rent, Wages, Interest, Profits
Supply of Goods and Services
Payment for Goods and Services
Factor Market
Goods Market
Real Flow or Barter Flow

3. Prepared by Dr. Samita Mahapatra
3
GOVERNMENT
SECTOR
FINANCIAL
SECTOR
Savings Investment
Direct Taxes
Infrastructure
Facilities Infrastructure
&
Subsidies
Direct and indirect Taxes
HOUSEHOLD
SECTOR
FIRMS
Savings
Investment
Supply of Goods and Services
Payment for Goods and Services
Land, Labour, Capital, Organization
Rent, Wages, Interest, Profits
Y = C + S Where; Y is disposal income, C is Consumption
and S is Savings

4. Prepared by Dr. Samita Mahapatra
4
GOVERNMENT
SECTOR
FINANCIAL
SECTOR
Savings Investment
Direct Taxes
Infrastructure
Facilities Infrastructure
&
Subsidies
Direct and indirect Taxes
HOUSEHOLD
SECTOR
FIRMS
Savings
Investment
Supply of Goods and Services
Payment for Goods and Services
Land, Labour, Capital, Organization
Rent, Wages, Interest, Profits
EXTERNAL
SECTOR
Remittances
Payment (Imports)
Receipts
(Exports)
Manpower
C
I
G
X - M

5. GDP or Aggregate Demand = C + I + G + X - M
C + S + T + M = C + I + G + X
Where; C = Consumption,
S = Savings,
T = Taxes,
M = Imports
Where; C = Consumption,
I = Investment,
G = Government Expenditure,
X = Exports
Therefore; S + T + M = I + G + X
Leakages Injections
GDP or AD GDP or AD

6. Consumption
• Consumption function is a functional statement of the
relationship between disposable income (Y) and the
consumption expenditure (C) .
• The consumption expenditure is a positive function of
income. Whenever money income increases the
consumption expenditure also increases, but the increase in
consumption is not as much as increase in income.
Y = 𝐂 + 𝐒 C= 𝐟 (𝐘) S= 𝐟 (𝐘)
S = 𝐘 − 𝐂

7. 7
Factors affecting Consumption Function
Objective Factors:
• Level of Income.
• Distribution of NI
• Nature of the Income
• Availability of Goods.
• Taxation Policy
Subjective Factors:
• Nature of the people.
• Expectations about
future.
• The desire to save and
accumulate

8. 8
Factors affecting Consumption Function
Objective functions:
1. Level of Income: Consumption expenditure of people directly depends
upon the level of income. It means that higher the income, higher the
consumption and vice-versa. But, when income increases, the MPC
declines and vice versa.
2. Distribution of National Income:
The propensity to consume also depends upon the pattern of income
distribution. Because,
• Lower income groups have a higher MPC.
• Higher income groups have a lower MPC.
3. Nature of the Income: The propensity to consume is also determined
by the nature of income i.e., whether the income received is stable or
variable.
• If the family is uncertain about the income, then it will be very careful
in spending money. So it will consume less and save more.
• On the other hand, the family gets stable income, then it will have
higher propensity to consume and lower propensity to save.

9. 9
Factors affecting Consumption Function
4. Availability of Goods: If the essential goods are not
available (or in shortage), people may be forced to save
more. As a result, the consumption will be less. On the
other hand, if the consumption goods are easily available,
then there will be more consumption.
5. Taxation Policy: If government reduces the taxes, people
will increase their consumption and if government
increases the taxes then consumption will decrease.
Subjective factors:
1. Nature of the People: If people are very cautious,
calculative and believe in providing safety and security to
family, education of children, funds for marriage and other
social functions etc consumption will be less.
2. Expectations about future: If people expect rise in income
in near future then they will consume more and vice-versa.

10. 10
Factors affecting Consumption Function
3. The desire to save and accumulate: Some people consume
less and save more to accumulate wealth for show-off or
prestige.
In the short period, the slope of the consumption curve can
be constant. But in the long period the determinants of
consumption change so the slope of the curve also
changes.

11. 11
Propensity to Consume and Save
Average Propensity to
Consume (APC):
• It shows what proportion
(%) of income is being spent
i.e., it also means the ratio
of consumption
expenditure to income at
that level.
• For example, if the income
is Rs. 1000, and the
consumption is Rs. 700 then
APC will be
• APC = C / Y = 700 / 1000
• Therefore; 0.7 which also
means 70% of the income is
being spent.
Average Propensity to Save
(APS):
• It shows the ratio of total
saving to total income at a
given level of income.
• For example, if Y = Rs. 1000
and the Savings = Rs. 300
then,
• APS = S / Y
• I.e., 300 / 1000 = 0.3
APC + APS =1
APC - 1 = APS

12. Income (Y) and
Consumption (C)
Savings Average
Propensity to
Consume (APC)
Average
Propensity to
Save (APS)
C > Y S < 0 APC > 1 APS < 0
C = Y S = 0 APC = 1 APS = 0
C < Y S > 0 APC < 1 APS > 0
Relationship between Income, Consumption,
Savings, Average Propensity to Consume and Save:

13. Marginal Propensity to Consume:
Marginal Propensity to Consume (MPC):
• The ratio of additional consumption expenditure to the
additional income is known as marginal propensity to
consume (MPC).
• For example, if income increases by Rs. 1000 and
consumption increases by Rs. 600 then MPC = 0.6 or 60 % i.e.,
the consumer spends 60% from the additional income.
𝐌𝐚𝐫𝐠𝐢𝐧𝐚𝐥 𝐏𝐫𝐨𝐩𝐞𝐧𝐬𝐢𝐭𝐲 𝐭𝐨 𝐂𝐨𝐧𝐬𝐮𝐦𝐞 𝐌𝐏𝐂 =
∆𝐂
∆𝐘
𝐓𝐡𝐞𝐫𝐞𝐟𝐨𝐫𝐞, 𝐌𝐚𝐫𝐠𝐢𝐧𝐚𝐥 𝐏𝐫𝐨𝐩𝐞𝐧𝐬𝐢𝐭𝐲 𝐭𝐨 𝐂𝐨𝐧𝐬𝐮𝐦𝐞(𝐌𝐏𝐂) =
𝟔𝟎𝟎
𝟏𝟎𝟎𝟎
= 0.6

14. • It shows the ratio of additional savings to additional
income. i.e., additional savings made from the
additional income.
For example, if income increases by Rs. 1000 and
Savings increases by Rs. 400 then, 400 / 1000 = 0.4
of 40% of the additional income is saved.
Marginal Propensity to Save:
𝐌𝐚𝐫𝐠𝐢𝐧𝐚𝐥 𝐏𝐫𝐨𝐩𝐞𝐧𝐬𝐢𝐭𝐲 𝐭𝐨 𝐒𝐚𝐯𝐞 𝐌𝐏𝐒 =
∆𝐒
∆𝐘
𝐓𝐡𝐞𝐫𝐞𝐟𝐨𝐫𝐞, 𝐌𝐚𝐫𝐠𝐢𝐧𝐚𝐥 𝐏𝐫𝐨𝐩𝐞𝐧𝐬𝐢𝐭𝐲 𝐭𝐨 𝐒𝐚𝐯𝐞 (𝐌𝐏𝐒) =
𝟒𝟎𝟎
𝟏𝟎𝟎𝟎
= 0.4
MPC + MPS =1 So, MPC = 1 - MPS

15. 15
DI (Y)
(Rs.)
C
(Rs.)
APC =
C/Y
MPC =
⍙C/
⍙Y
S
(Rs. )
APS =
S/Y
MPS=
⍙S/
⍙Y
100 120
200 200
300 280
400 360
500 440
600 520
Aggregate Expenditure or Demand = C + I
DI (Y)
(Rs.)
C
(Rs.)
APC = C/Y MPC =
⍙C/
⍙Y
S
(Rs. )
APS =
S/Y
MPS=
⍙S/
⍙Y
100 120 1.2 - -20 -0.2 -
200 200 1 0.8 0 0 0.2
300 280 0.933 0.8 20 0.067 0.2
400 360 0.9 0.8 40 0.1 0.2
500 440 0.88 0.8 60 0.12 0.2
600 520 0.867 0.8 80 0.133 0.2

16. DI (Y)
(Rs.)
C
(Rs.)
S
(Rs. )
I AE = C + I I* AE = C + I
+ I*
100 120 -20 40 20
200 200 0 40 20
300 280 20 40 20
400 360 40 40 20
500 440 60 40 20
600 520 80 40 20
Aggregate Expenditure or Demand = C + I
DI (Y)
(Rs.)
C
(Rs.)
S
(Rs. )
I AE = C + I I* AE = C + I
+ I*
100 120 -20 40 160 20 180
200 200 0 40 240 20 260
300 280 20 40 320 20 340
400 360 40 40 400 20 420
500 440 60 40 480 20 500
600 520 80 40 560 20 580

17. 17
Y*
o
C
C+I
200 400
Disposal Income
X
Y
Aggregate
Expenditure
E1
E2
AE=C+I+I*
500
E3
100
45O

18. 18
Y*
o
C
C+I
200 400
Disposal Income
X
Y
Aggregate
Expenditure
E1
E2
AE=C+I+I*
500
E3
100
45O
X
o
I
I*
40
60
S
200 400 500
Saving,
Investment
E1
E2
E3
-20

19. 19
Investment Multiplier
Investment Multiplier (K) =
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑬𝒒𝒖𝒊𝒍𝒊𝒃𝒓𝒊𝒖𝒎 𝑫𝒐𝒎𝒆𝒔𝒕𝒊𝒄 𝑷𝒓𝒐𝒅𝒖𝒄𝒕
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒅𝒆𝒔𝒊𝒓𝒆𝒅 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
Investment Multiplier (K) =
𝟓𝟎𝟎 −𝟒𝟎𝟎
𝟔𝟎−𝟒𝟎
Therefore; K = 𝟐𝟎 𝒙 𝟓 = 𝟏𝟎𝟎 𝒄𝒓𝒐𝒓𝒆𝒔
Investment Multiplier (K) =
∆ 𝒀
∆𝑰
=
∆ 𝒀
∆𝑺
Investment Multiplier (K) =
𝟏
𝑴𝑷𝑺
=
𝟏
𝟏− 𝑴𝑷𝑪
Therefore; Investment Multiplier (K) =
𝟏
𝟎.𝟐
=
𝟏
𝟏−𝟎.𝟖
= 5

20. Multiplier Effect
• A change in one of the components of aggregate demand
(AD) can lead to a multiplied final change in the equilibrium
level of GDP.
Calculate the value of the investment multiplier when the
marginal propensity to consume (MPC) is
(i) 0.85
(ii) 0.70
(iii) 0.60 and
(iv) 0.40.
K =
𝟏
𝟏−𝑴𝑷𝑪
K =
𝟏
𝟏−𝟎.𝟖𝟓
= 6.67 K =
𝟏
𝟏−𝟎.𝟕𝟎
= 3.33
K =
𝟏
𝟏−𝟎.𝟔𝟎
= 2.5 K =
𝟏
𝟏−𝟎.𝟒𝟎
= 1.67

21. Investment

22. Acceleration Effect
Increase in
Consumer
demand
Firms get
close to full
capacity
Firms invest
to meet rising
demand

23. Acceleration Effect
• The ratio between the change in consumption and change in
induced investment is called acceleration coefficient.
• The accelerator effect is the relationship between planned
capital investment and the rate of change of national
income.
• Consider an industry where the demand is rising quickly.
• Firms may respond initially by using their existing productive
capacity more intensely or running down stocks of finished
products.
• If they expect high demand will be sustained – they may
increase spending on plant and machinery, factories new
technology in order to increase their supply capacity.
• This will cause acceleration effect: where a given change in
demand for consumer goods and services will cause a bigger
percentage change in demand for capital goods.

24. Investment: I = f (i)
• At macro level, investment is defined as the aggregate
expenditure of the economy on currently produced capital
goods like machinery, buildings, additions to stock of goods
etc.
• Marginal Efficiency of Capital (MEC): Investment has two
components:
a. Fixed investments – is the new expenditure incurred on
purchase of fixed capital goods like machinery, ships,
trucks, buildings etc.
b. Inventory investments – is the expenditure incurred on
holding increased amounts of stocks of raw materials and
unsold goods by the firms.
Thus, MEC is the internal rate of return of an extra unit of
capital

25. • Keynes coined a new term Marginal Efficiency of
Capital to explain economic fluctuations.
• Marginal Efficiency of Capital (MEC) – the rate of
return which an investor expects to earn on the last
unit of capital employed or from the investment at
the margin.
Investment : I = f (i)
Rate of Investment
Marginal Efficiency
of Capital
Rate of
Interest
Prospective
Yield
Supply Price of
Capital Goods
Entrepreneurial
Expectations
When the
entrepreneurial
expectations are high,
this increases the
marginal efficiency of
capital, hence
entrepreneurs make
huge investments.

26. Investment : I = f (i)
0
Level of Investment
Rate
of
Interest
Y
X
MEC
i1
I1
i2
I2
MEC does not remain constant
over time. When investment
in the economy increases MEC
falls because increase in
investment , results in higher
demand for capital goods and
the increased supply of capital
(C), it results in decrease in
marginal product of capital and
the amounts of net income
generated.
Higher the i lower is the I and
vice-versa
E =
𝑸
𝑷

27. Factors Influencing MEC
Short-term factors:
1. Expected demand in
the economy
2. Cost and Prices
3. Propensity to
consume
4. Changes in Income
5. Current rate of
expectations
6. State of Business
Confidence
Long-term factors:
1. Rate of growth of
Population
2. Development of new
areas
3. Technological Progress
4. Productive capacity of
the existing capital
equipment
5. Rate of current
investment

28. Expected demand in the Economy AD MEC
Factors Influencing MEC : Short term
Cost and
Prices
Cost Price MEC
Cost Price MEC
Propensity to
Consume
Consumer
Goods Capital Goods MEC
Changes in Income Income Investment MEC
Current state of
expectation
Expected Return is High MEC
State of Business Confidence
(outlook of Businessman or firms)
Positive MEC
Negative MEC

29. Rate of growth of
Population
Consumption
AD Investment MEC
Factors Influencing MEC : Long-term
Development of new Infrastructure Investment MEC
Technological Progress Investment MEC
Productive capacity of the existing
capital equipment Investment MEC
Rate of current investment High MEC

30. Business Cycles
Business cycles are a type of fluctuation found in the aggregate
economic activity of nations that organize their work mainly in
business enterprises. A cycle consists of expansions occurring at
about the same time in many economic activities, followed by
similarly general recessions, contractions and revivals which
merge into the expansion phase of the next cycle; the sequence
of changes is recurrent but not periodic; in duration business
cycles vary from more than one year to 10 or 12 years.
Business Cycles has Four Stages:
1. Recession
2. Depression
3. Recovery or Revival
4. Boom or Prosperity

31. Potential
GDP
Peak
Troughs
TIME
Real
GDP
0
X
Y

33. Practice Multiple Choice
Questions
5/10/2021
Prepared by Dr. Samita
Mahapatra

34. 1. The components of aggregate demand is/ are:
a. Household consumption expenditure
b. Government Expenditure
c. Private and public investment expenditure
d. All of these
2. Suppose the level of income of Saudi economy is SR 50,000
million and consumption is SR 40,000 million. What is the
average propensity to consume for the Saudi economy?
a. 0.6
b. 0.8
c. 0.7
d. 1.2
APC =
𝑪
𝒀
=
𝟒𝟎𝟎𝟎𝟎
𝟓𝟎𝟎𝟎𝟎
= 𝟎. 𝟖

35. 3. Suppose the income increases from SR 50,000 million to SR
60,000 million and as a result consumption increases from SR
40,000 to SR 47,000 million in Saudi economy. What is the
marginal propensity to consume for the Saudi economy?
a. 0.6
b. 0.7
c. 0.8
d. 0.9 MPC =
∆𝑪
∆𝒀
=
𝟒𝟕𝟎𝟎𝟎 −𝟒𝟎𝟎𝟎𝟎
𝟔𝟎𝟎𝟎𝟎 −𝟓𝟎𝟎𝟎𝟎
=
𝟕𝟎𝟎𝟎
𝟏𝟎𝟎𝟎𝟎
= 𝟎. 𝟕
4. The consumption function shows the relationship between
consumption and:
a. Interest rates.
b. Saving.
c. Price level changes.
d. Disposable income.

36. 5. The slope of the consumption function is called the:
a. autonomous consumption rate.
b. marginal consumption rate.
c. average propensity to consume.
d. marginal propensity to consume.
6. The marginal propensity to save is:
a. the change in saving induced by a change in consumption.
b. (change in S) / (change in Y).
c. 1 - MPC / MPC.
d. 1 - MPC.
7. If the marginal propensity to consume = 0.75, then:
a. the marginal propensity to save = 0.75.
b. the marginal propensity to save = 1.33.
c. the marginal propensity to save = 0.20.
d. the marginal propensity to save = 0.25.

37. 8. MEC is directly related to:
a. Prospective yield
b. Supply price
c. Rate of interest
d. All of these
9. Value of MPC is:
a. >1
b. < 1
c. =0
d. 0 < MPC >1
10 When MPS = 0.2, MPC will
be:
a. 0.8
b. 0.2
c. 1.2
d. 20
The sum of marginal propensity to
consume plus marginal propensity to
save must equal to:
a. 0
b. 1
c. 100
d. 1000

38. Reference Books
• Macroeconomics: Theory and Policy – D. N.
Dwivedi, Tata McGraw Hill Publications
• Macroeconomics –Abel and Bernanke, Pearson
Publications
• Macroeconomics: Theory and Policy – Vanita
Agarwal, Pearson Publication.
• Managerial Economics – H. L. Ahuja, S. Chand
Publications.
• Managerial Economics in a Global Economy (5th
Edition) – Dominik Salvatore, , McGraw Hill, New
Delhi.
38