Consumption Function overview

2. Spending in the Economy
The sectors that spend in the economy are:
Consumers
Business Firms
Government
International Sector

3. Spending in the Economy
AD = C + I + G + Nx

4. Consumption Expenditure expenditure done by
households on final goods and services
Consumption is the largest component of AD
Consumption spending is relatively stable

5. Durable Goods
3 Components of Consumption Spending
Nondurable Goods Services
Goods that last a long time
Goods that are consumed very
quickly Work performed for others

7. Consumption Function
As we earn higher levels
of income (Yd) our
consumption increases
C
Yd
C
45
0

8. 45
C
C
Yd
Consumption Function
E
A
B
Equilibrium
We consume all
of our income
Yd = C
Yd > C
Earning more
than we spend
C > Yd
Spending more
than we earn

9. C
Yd
C
45
0
C2
C3
Consumption increases at every
level
Consumption decreases at
every level

10. Wealth
Wealth includes those things you own such as your property
holdings, stock portfolio, or any other asset that has value.
Wealth is NOT your income
An increase in wealth will increase your consumption
A decrease in wealth will decrease your consumption

11. Expectations
Expectations deal with expected future changes in income.
If you expect your future income to increase you may increase your spending today
If you expect your future income to decrease you may decrease your spending
today.
I get a job with
Google that
begins in three
months. The job
pays more than I
now get. I will
start increasing
my consumption
expenditures.

12. Debt
Debt deals with how much you owe.
If you have a large amount of debt you may decrease your spending
If you have little or no debt you may increase your spending

13. Real Interest Rate
The real interest rate deals with the interest you pay on purchases that have been
financed – such as buying a large TV at Best Buy.
If the real interest rate fall your consumption may increase
If the real interest rate increases your consumption expenditures may fall.

14. Taxes
Taxes deals with the taxes you pay on your income.
If the taxes you pay falls your consumption expenditures will increase
If the taxes you pay increases your consumption expenditures will decrease.