Consumption Function

1. Consumption Function
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2. Income
• It is the incoming or inflow of money for a person, company,
organization and government for a period of time or at given point
of time.
• It is the return for utility of a person’s services.
• It is sacrificing the utility of money for others.
• Income varies in terms of its frequency and volume depending on
the source or type nature of income.
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3. Types of Income
A. Personal income : Salary, Fees, Remuneration
B. Savings Income: Periodic interest, Cumulative Interest
C. Investment Income: Dividend, Capital Gain
D. Business Income: Profits, Income from sale of assets and
Reinvestment returns
E. Other Income: Lottery, Gambling, TV Shows and other income
in the absence of above mentioned.
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4. Income
A. Personal income
• Salary
• Fees
• Remuneration
B. Savings Income
• Periodic interest
• Cumulative Interest
C. Investments Income
• Dividend
• Capital Gain
D. Business Income
• Profits
• Sale of assets
• Reinvestment returns
E. Other Income
• Lottery
• Gambling
• TV Shows
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5. Income
The earned Income takes the following forms
• Disposable Income (Y) : Income left after standard deductions like taxes,
donations and other personal commitments.
• Consumption Expenditure (C) : Spending the income on current needs
or / and future needs.
• Savings (S): Asset and portfolio motive making the surplus money
parked in Time deposits of banks. Further banks lend them to deficit
money units like business houses for their investments making savings as
a channel for indirect investments.
• Investment Expenditure (I) : Investments in non banking instruments
like shares, real assets, business, etc..
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6. Income
Income can be summarized as follows
Income (Y) = Consumption Expenditure (C) + Investment Expenditure (I)
(or)
Income (Y) = Consumption Expenditure (C) + Savings (S)
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7. What is the difference between Savings and Investments?
Savings
• Transforms earnings into
investments indirectly.
• Time lag to reach the deficit and
make investments.
• Not assured to become
investments.
• Low risk or know risk nature.
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Investments
• Transforms earnings directly into
investments.
• No time lag as there are no channels
between the surplus and deficit.
• Meant for investments.
• Risky nature

8. What is the difference between Savings and Investments?
Savings
1. Narrow money with individuals
reaches savings accounts.
2. Narrow money in savings account of
from the individuals directly gets
converted into Broad Money.
3. Broad Money with Banks, Financial
Institutions and Post Offices is given as
loan to capital deficits (Business house
and Government).
4. Business and government do
investment expenditure.
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Investments
1. Narrow Money gets converted into
investments reaching business
houses and government bodies.
2. Business and government do the
investment expenditure.

9. Income, consumption, savings and investments
- Are they macro or micro economic variables?
• Income, expenditure, investment and savings are the most
important variables for a person to become wealthy.
• Till here it seems like micro economics as these variables relate to
a person or a company.
• Surprisingly they are more relevant and more over part of macro
economic functions.
• Any country or economy which looks forward to flourish should
focus on aggregate income, savings, investments and consumption
which are needed for GDP growth rate with stable prices and full
employment.
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10. Consumption
It is the present monetary expenditure on daily consumables or /and future
needs. Important factors which lead to consumption are
1. Income redistribution
2. Wage and Income Policy
3. Subsidies : Price and interest rates
4. Populist schemes: Loan waiver to farmer, Annual cash limit for farming,
Fee reimbursement.
5. Social security schemes: Unemployment compensation, Old age
pensions
6. Consumer credit
7. Urbanization: Economic development.
8. Advertisement
9. Tax concession and holidays
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11. Consumption
Primarily consumption is the function of disposable income. Income
(y) and consumption (C) can be related in three different ways.
1. Y = C
Whole of the income is spent on consumption, savings become zero.
2. Y< C ; Y- C = Positive
After consumption income is left out for savings.
3. Y< C ; Y- C = Negative
Unavoidable or unwanted consumption which is possible in real through
borrowings or accumulated savings.
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12. Consumption Function
Primarily consumption is the function of Income. Further they can be
categorized as
1. Disposable Income (Y)
2. Autonomous consumption (cA)
3. Induced Consumption
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13. 1. Disposable Income (Y)
• It is also called as net income or income which is the income left
over after Tax deductions, Donations and Other personal
commitments. Simply income after taxes and trasfers.
• Income (Y) determines consumption (C).
• Consumption decisions are based on current and future income.
• Current period income = current income plus present value of
future income; Y1 + Y2 / (1 + k), where r is a discount rate.
• Future period income = future income plus future value of
current income: (1 + k)Y1 + Y2
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14. 1. Disposable Income (Y)
Source : Trading Economics
Disposable Personal Income increased to Rs 1,92,81,745 Cr in 2018 from Rs 1,69,62,397 in 2017.
• Average Rs 22,81,277 Cr (1950 to 2018)
• High of Rs 1,92,81,745 Cr in 2018
• Low of Rs 9,154 Cr in 1950
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15. 2. Autonomous consumption (cA)
• It is the level of consumption which does not depend on income or
changes in periodic income level and even when it is zero.
• It means one has to spend on food, shelter and basic needs without
income by borrowing or riding on the accumulated savings.
• In the long-run, autonomous consumption falls to zero
• Autonomous consumption vanishes in the long run as a person
takes care of the priorities with past experience.
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16. 3. Induced Consumption (cI)
It is the consumption which is influenced or induced by the change in the level of
income.
• Propensity to Consume: It is the proportion of disposable income to spend on
consumption. Ex : Rs 4,50,000 is the annual consumption from an annual salary of
Rs 10,00,000. This makes 0.45 as the propensity to consume.
• Marginal Propensity to Consume (MPC): It is the metric to quantify Induced
Consumption (cI). MPC is the proportion of additional income that an individual
consumes. Ex: Annual salary has gone up by Rs 1,00,000, for the same yer
consumption has gone up by Rs 50, 0000. This makes MPC of 0.50 which is fifty
percent of the marginal income.
• Average Propensity to Consume (APC) : It is the average of all the MPC for
every change income (Y)
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17. Marginal Propensity to Consume (MPC)
• It is the metric to quantify Induced Consumption (cI). MPC is the proportion of
additional income that an individual consumes. Ex: Annual salary has gone up by
Rs 1,00,000, for the same year consumption has gone up by Rs 50,000. This makes
MPC of 0.50 which is fifty percent of the marginal income.
• MPC = ΔC/ΔY
• MPC Varies between zero and one ; 0 < MPC < 1
• MPC > 1 with borrowed funds or consumption with accumulated savings.
• MPC < 0 if consumption reduces with increased income.
• High income families have a higher marginal propensity to save (MPS = 1 – MPC)
• High income families have a higher average propensity to save (APS = 1 – APC);
APC falls with the level of income.
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18. Average Propensity to Consume (APC)
• It is the average of all the MPC for every change income (Y).
• It is the sum of all MPC for every change in income (Y) / number
of changes in Income (n).
• Average propensity to consume (APC) falls as income rises.
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19. Consumption Function – Long Term
Consumption is a linear function of disposable personal income
C = Y*MPC
Where
C = Consumption expenditure
Y = Disposable income
MPC = Marginal Propensity to Consume (slope of the line)
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20. Keynes Law of Consumption
The relationship between Income (Y) and Consumption (C) is given 3
propositions explained in the following table and figures.
1. Increase in income (ΔY) leads to increase in consumption (ΔC) but by
smaller amount comparatively.
2. Increased income (ΔY) is divided in some proportion between
consumption (ΔC) and savings (ΔS).
3. Increase in income (ΔY) always leads to an increase in both
consumption (ΔC) and savings (ΔS).
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21. Consumption Function
Yr
Annual
Income
(Y)
Marginal
Income
(ΔY)
%Ch
ange
in Y
Annual
Consumption
(C)
Marginal
Consumption
ΔC
% Change
in
Consumpti
on
Annual
Consumption
Ratio
MPC
(ΔC/ΔY)
Savings(S) =
Y-C
MPS =
1- MPC
0 0 0 120,000 120,000 0.00 0.00 0 0.00
1 120,000 120,000 100 120,000 120,000 0 1.00 1.00 0 0.00
2 180,000 60,000 50 162,000 42,000 35.00 0.90 0.70 18,000 0.10
3 270,000 90,000 50 216,000 54,000 33.33 0.80 0.60 54,000 0.20
4 359,100 89,100 33 269,325 53,325 24.69 0.75 0.60 89,775 0.25
5 477,603 118,503 33 334,322 64,997 24.13 0.70 0.55 143,281 0.30
6 597,004 119,401 25 358,202 23,880 7.14 0.60 0.20 238,802 0.40
7 746,255 149,251 25 380,590 22,388 6.25 0.51 0.15 365,665 0.49
8 932,818 186,564 25 401,112 20,522 5.39 0.43 0.11 531,706 0.57
9 1,119,382 186,564 20 414,171 13,059 3.26 0.37 0.07 705,211 0.63
10 1,287,289 167,907 15 424,805 10,634 2.57 0.33 0.06 862,484 0.67
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22. Consumption Function – Long Term
Disposable Income (Y)
Consumption
Expenditure (C)
Y* MPC
• MPC is the slope of the line.
• As income (Y) increases, MPC also increases.
• As income (Y) decreases, MPC also decreases.
• The rate of change in MPC is less than rate of change in
income (Y). MPC < ΔY.
• Increase in consumption is less than increase in Income (Y).
• Fall in consumption is less than fall in Income (Y).
• Average Propensity to Consume (APC) is Constant.
C
Y
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23. Consumption Function – Short Term
Consumption is a linear function of disposable personal income
C = ca + Y*MPC
Where
ca = Autonomous Consumption
C = Consumption expenditure
Y = Disposable income
MPC = Marginal Propensity to Consume (slope of the line)
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24. Consumption Function – Short Term
Y
C
• MPC is the slope of the line.
• As income (Y) increases, MPC also increases.
• As income (Y) decreases, MPC also decreases.
• The rate of change in MPC is less than rate of change in
income (Y).
• Increase in consumption is less than increase in Income
(Y) ;
• Fall in consumption is less than fall in Income (Y) ;
MPC < ΔY.
• APC falls as Y increases
ca
cI
Y
C
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25. Determinants of Consumption Function
• Individual Motives
• Business Motives
• Demonstration Effect
• Corporate financial policies
• Changes in fiscal policy
• Changes in expectations
• Change in income or wages
• Windfall gains or losses
• Changes in Interest rate
• Holding liquid assets
• Income distribution
• Savings
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26. Thank You
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