This presentation intended to help researchers and students to easily access different topics in economics

1. Continuation…

2. • Analyze the Theory of Consumption
• Cite specific examples to explain the concept of income and
substitution effects to consumers.
• Discuss the application of the Law of Diminishing Returns in
production.

3. Consumption is a major concept in economics and
also studied by many other social science.
Economists are particularly interested in the
relationship between consumption and income, as
modeled with the consumption function.

4. The term consumption derived from old French
word “consumpcion” and Latin word
“consumptionem”
(www.etymoline.com)

5. Different schools of economists define consumption
differently.
According to Encarta Encyclopedia, “ The process
and use of goods and services by consumers or the
quantity of goods and services purchased”

6. According to David Jary and Julia Jary, “The
process in which goods or services are used to
satisfy economic needs”

7. According to Merriam-Webster Learner’s Dictionary,
eating or drinking something: the use of something:
use by a particular group of people”.
In simple words, consumption means demand for
consumer goods and services by households as
well.

8. Modern economist emphasize much on it:
1. Index of standard of living: The consumption
pattern of a person ; i.e. what he/she eats, what
he/she wears etc. give us the knowledge of the
standard living of a person.

9. 2. Consumption is the source of production:
Production increase with the consumption. It is
consumption of goods that necessities their
production.

10. 3. Consumption is important in economic theory:
the study of consumption has contributed much in
the formulation of certain economic principles.

11. 4. Consumption is important for the government: the
government formulates its economic policies on the
basis of consumption habits of the people.

12. 5. Consumption is important in income and
employment: consumption plays an important role
in the determination of income, output and
employment in a country.

13. 5. Consumption is important in income and
employment: consumption plays an important role
in the determination of income, output and
employment in a country.

15. 1. Theory of Alfred Marshall
Alfred Marshall ( July 26, 1842- July 1924) was one of the
most influential economist of his time. He was born in
London. His father was a bank cashier and at the same
time Evangelical. He was educated at the Merchant
Taylor’s School and St. John’s College, Cambridge.

16. Major books of Marshall:
The economics of Industry- 1879
Principle’s of Economics- 1890
Industry and Trade- 1919
Money, Credit and Commerce- 1923

17. Theory of Marshall on consumption
Marshall indicated that many human wants are structured in
relation to cultural and social patterns. His connection
between wants and activities led to this insight. Marshall
recognized the existence of certain necessaries for
subsistence and for different occupation.

18. Limitations of Theory of Marshall:
In his theory, something besides residual wants,
determined demand, wants depend in part on the type
of civilization in which the economy is embedded.

19. 2. Theory of Thorstein Veblen on Consumption
Thorstein Bunde Veblen ( July 30, 1857- August 03, 1929)
was a Norwegian-American economist and sociologist.
He was famous as a witty critic of capitalism. He was the
fourth of twelve children in the Veblen Family.

20. Major books of Veblen:
The theory of Leisure Class – 1899
The theory of Business Enterprise- 1904
Empirical Germany and the Industrial revolution- 1915
The vested interests and the common man - 1919

21. Theory of Maynard Keynes on Consumption
John Maynard Keynes ( June 5, 1883- April 21, 1946) was an
English economist whose ideas fundamentally changed the
theory and practice of macro-economics and the economic
policies of gov’t. John Maynard Keynes was born in Cambridge
England to a upper-middle class family. His Father was an
economist and a lecturer in Moral Sciences at the University of
Cambridge and his mother was a local social reformer.

22. Contribution:
Macroeconomics, Keynesian Economics, Liquidity preference,
Spending Multiplier.
Major books of Keynes:
1913- Indian Currency and Finance
1914- Ludwig Von Mise’s Theori des Gelds.
1919- The Economic Consequences of the Peace.

23. Theory of Keynes
The work of Keynes brought into focus the balance between
consumption and savings. His theory of consumption and savings
rests on what he called a “Fundamental Psychological Law”
whereby when (any modern communities) real income is
increased (the community) will not absolute amount must be
saved.

25. 1. INCOME- Current real income is the most important
determinant of consumption in the short run. We spend
according to the income coming in. This is the basis for most
consumption theory. The term ‘real’ refers to how our income
is affected by inflation, or the natural rise in prices of goods
and services. Inflation and income are interrelated to with
each other.

26. 2. PRICES- if prices are higher, then a person’s total level of
consumption will be lower, because consuming will use up a
higher percentage of a person’s income.

27. 3. Taxes- as taxes on goods and services rise, people may not be
able to afford as much as they used to and as a result will
consume less. The income tax rates will also affect our ability and
decision to consume. Higher taxes rates lead to less disposable
income left.

28. 4. SAVINGS- people generally have two things they can do with
their money. They can save or they can spend. The more money
people save, the less, they have to consume in the short run.

29. 5. CONSUMER PREFERENCES- consumer choice, taste and
preferences also affects our consumption pattern. Sudden
panic, rumours also affects our consumption pattern.

30. 5. CONSUMER CONFIDENCE- if people are worried about the
economy of their own future income, they may delay making
purchases in order to provide some safety and extra cash for
future expenses. They will save or delay their consumption until
they feel better about what lies ahead.

31. 6. GOVERNMENT POLICIES- Various policies can also affect our
consumption pattern.
7. OTHERS- age, family status, sex, family size etc. can also
determine consumption.

34. The income effect is the change in the consumption of
goods by consumers based on their income. The
substitution effect happens when consumers replace
cheaper items with more expensive ones when their financial
conditions change.

35. The income effect expresses the impact of increased purchasing
power on consumption, while the substitution effect describes
how consumption is impacted by changing relative income and
prices. These economics concepts express changes in the market
and how they impact consumption patterns for consumer goods
and services.

36. Different goods and services experience these changes in different
ways. Some products, called inferior goods, generally decrease in
the consumption whenever incomes increase. Consumer spending
and consumption of normal goods typically increases when
income also increases.

37. In economics, an inferior good is a good that decreases in
demand when the income of the consumer rises. People with
little income might buy bread in the supermarket, but when
their income increases, they buy their bread in the well-
known bakery instead. ... Goods where the demand rises
with the income are called normal goods.
To better understand….

40. The income effect is the change in the consumption of goods
based on income. This means consumers will generally spend
more if they experience an increase in income, and they may
spend less if their income drops. But the effect doesn't dictate
what kind of goods consumers will buy. They may opt to purchase
more expensive goods in lesser quantities or cheaper goods in
higher quantities, depending on their circumstances and
preferences.

41. The marginal propensity to consume explains how consumers
spend based on income. It is a concept based on the balance
between the spending and saving habits of consumers. The
marginal propensity to consume is included in a larger theory of
macroeconomics known as Keynesian economics. The theory
draws comparisons between production, individual income, and
the tendency to spend more of it.

42. The substitution may occur when a consumer replaces
cheaper or moderately priced items with ones that are
more expensive when a change in finances occurs. For
example, a good return on an investment or other
monetary gains may prompt a consumer to replace the
older model of an expensive item for a newer one.

43. While the substitution effect changes consumption
patterns in favor of the more affordable alternative, even a
modest reduction in price may make a more expensive
product more attractive to consumers. For instance, if
private college tuition is more expensive than public
college tuition—and money is a concern—consumers will
naturally be attracted to public colleges.

44. The substitution effect is not just limited to consumers.
When companies outsource part of their operations, they
are using the substitution effect. Using cheaper labor in a
different country or by hiring a third party results in a drop
in costs. This nets a positive result for the corporation, but
a negative effect for the employees who may be replaced.

45. •The income effect is the change in the consumption of goods by consumers based on
their income.
•The substitution effect happens when consumers replace cheaper items with more
expensive ones when their financial conditions change.
•The income effect can be both direct (when it is directly related to a change in income)
or indirect (when consumers must make buying decisions not directly related to their
incomes).
•A small reduction in price may make an expensive product more attractive to
consumers, which can also lead to the substitution effect.

47. The marginal utility may decrease into negative utility, as it
may become entirely unfavorable to consume another unit
of any product. Therefore, the first unit of consumption for
any product is typically highest, with every unit of
consumption to follow holding less and less utility.
Consumers handle the law of diminishing marginal utility
by consuming numerous quantities of numerous goods.

48. An individual can purchase a slice of pizza for $2, and is
quite hungry, so they decide to buy five slices of pizza.
After doing so, the individual consumes the first slice of
pizza and gains a certain positive utility from eating the
food. Because the individual was hungry and this is the first
food consumed, the first slice of pizza has a high benefit.
Example of Diminishing Utility

49. Upon consuming the second slice of pizza, the individual’s
appetite is becoming satisfied. They are not as hungry as
before, so the second slice of pizza had a smaller benefit
and enjoyment than the first. The third slice, as before,
holds even less utility as the individual is now not hungry
anymore.

50. The fourth slice of pizza has experienced a diminished
marginal utility as well, as it is difficult to be consumed
because the individual experiences discomfort upon being
full from food. Finally, the fifth slice of pizza cannot even
be consumed. The individual is so full from the first four
slices that consuming the last slice of pizza results in
negative utility.

51. The five slices of pizza demonstrate the decreasing utility
that is experienced upon the consumption of any good. In
a business application, a company may benefit from having
three accountants on its staff. However, if there is no need
for another accountant, hiring another accountant results
in a diminished utility, as there is a minimum benefit
gained from the new hire.

52. RECAP….

53. CONSUMPTION ACCORDING TO:
1. MARSHALL
2. VEBLEN
3. KEYNES

54. DETERMINANTS OF CONSUMPTION

55. INCOME AND SUBSTITUTION EFFECTS

56. LAW OF DIMINISHING MARGINAL UTILITY