USB:MBA – Industry Collaborated Programs

Subject Name- Managerial Economics

Faculty Name: Dr. Vipin Sharma

Consumption Function DISCOVER . LEARN . EMPOWER

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 Objective
Consumption Function • The course aims to familiarize the
students the concepts of
Consumption Function as it is
applicable in the real world situation.
Course Outcomes Agenda of the Lecture
CO Title Level
1. Consumption Function?
Num 2. Cyclical and Secular Consumption
ber
To introduce core concepts of Market
function
CO1 Remember
structure Perfect Competition 3. Determinants?
CO2 To Learn process of Price determination in Remember
the Short Run and the Long Run 4. Psychological Law of Consumption
CO3 To Learn process of producer’s equilibrium Remember
in the Short Run and the Long Run

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 Consumption: Meaning-:
• Whenever we make use of any commodity or service for the satisfaction of our wants, the act is called
consumption.
• Consumption has also been defined as destruction of utility: Man cannot create matter nor can he destroy
it. Matter is there in the world, it will remain there; man can only change its form. When a man eats, a mango,
he does not destroy the matter of which it is composed; he has only changed its form. Formerly, it could satisfy
a human want, i.e., it possessed utility; now that want-satisfying power is gone. In other words, man has
destroyed its utility in the act of eating it. The mango has been consumed.
• The destruction of utility in consumption may be quick and immediate as in the case of a mango or a glass
of milk. Or it may be a prolonged and slow process as in the case of furniture. In both cases, utility or want-
satisfying power is being destroyed.
• But mere destruction of utility does not mean consumption. If a house catches fire and is destroyed, it has
not been ‘consumed’ in the economic sense. Consumption implies the satisfaction of a human want.
• The emphasis is on the satisfaction of wants rather than on the destruction of utility. If no want has been
satisfied, it is not consumption. For practical purposes, consumption means the spending of money
income. Milk, food and other goods that we consume cannot be had free we must pay for them.

• Consumption, thus, involves expenditure of income or wealth-using activity of man.

 Importance of ‘Consumption’ concept-:
• It is consumption which gives the initial push to production.
Production, thus, is directed and stimulated by consumption (consumption
is the beginning as well as the end of all economic activity).
• The existence of wants is the mainspring of all economic activity and then
multiplying or expansion is the secret of all economic progress.
Multiplication of wants and economic progress go together. Manufacturers
try to find out better and more profitable methods to satisfy the consumers.
This leads to the discovery of new products and new processes and
the invention of new machines. Every economic effort made to satisfy
one want creates more wants. The more the wants are satisfied, the more
they increase. “Appetite comes with eating.”
• Consumers direct and guide production. It is the intensity of consumers’
desires which determines prices in the market. It exerts its influence
on exchange also. Without consumption there would have been no
exchange.
• Distribution, i.e., the flow of incomes to landlords, workers, capitalists
and organizers, is also influenced by the consumption (standard of
living) of each of these classes. Standard of living determines their
efficiency and on efficiency depends their shares in the national income.
 Types of Consumption:
• AUTONOMOUS CONSUMPTION: The
consumption which is not
dependent on income level. It will
exist even at zero income level. This
consumption at zero level of
income is financed by Dis-savings
or use of past savings.
• INDUCED CONSUMPTION: The
consumption which is dependent
on the level of income. This
consumption level increases with
the level of income.

Eco-Trivia: Psychological law of consumption given by Keynes states that consumption increases with the increase in
income, however the proportion of increase in consumption is less than the proportion of increase in income.
 Technical Attributes of consumption-:
• Average Propensity to Consume (APC): the ratio of aggregate or total
consumption to aggregate income in a given period of time.
Symbolically, APC = C/Y
• In highly industrialized economies, the APC is persistently low and the
APS is persistently high.
• Marginal Propensity to Consume (MPC): The
marginal propensity
to consume (MPC) is the ratio of the change in the level of
aggregate consumption to a change in the level of aggregate
income. The MPC, thus, refers to the effect of additional
income on consumption. Symbolically,
• MPC = ∆C/∆Y
• Where, ∆ (delta) indicates the change (increase or decrease),
• С=consumption
• Y=income.
• MPC always lies between 0 and 1 (0≤MPC ≤1)
• From MPC, we can calculate MPS (Marginal PROPENSITY TO Save) =
MPS= 1-MPC, Alternatively MPC+MPS = 1
 Table for APC, APS, MPC, MPS:
Income Consumption (C) Saving AC AS APC APS MPC(Rs) MPC
(Y) (Rs) (Rs) (S) (Rs)

0 20 -20 – – – – – –
100 110 -10 90 10 1.10 -0.10 0.90 0.10
200 200 0 90 10 1 0 0.90 0.10
300 290 10 90 10 0.97 0.03 0.90 0.10
400 380 20 90 10 0.95 0.05 0.90 0.10
500 470 30 90 10 0.94 0.06 0.90 0.10
600 560 40 90 10 0.93 0.07 0.90 0.10
Formulae used:
(I) S= Y-C
(ii) APC = C/Y = 1- APS
(iii) APS = S/Y = 1 – APC
(iv) MPC = ∆C/∆Y =1- MPS
(v) MPS= ∆S/∆Y = 1- MPC
Values of APC, APS, MPC and MPS:
The values of MPC and MPS varies between 0 and 1,
whereas, APS can be even less than 1 and APC can be
more than 1.
Contd.

• The MPC may rise, fall or remain constant between the limits set. However,
Keynes implicitly stated that the MPC will not be constant when cyclical
fluctuations cause change in objectives factors determining the propensity to
consume. Thus, it may be inferred that during the cyclical upswing, the MPC
will fall while during the downswing, it will rise.
• MPC is higher in the case of poor than in that of rich people. Therefore, in
underdeveloped countries, the MPC tends to be high, whereas in advanced
countries it tends to be low. Consequently, the MPC is high in rich sections
and is low in poor sections of the community. The same is true of rich
nations and poor nations.
 Relationship Between APC and MPC-:

• When the MPC is constant, the

consumption function is linear,
i.e., a straight line curve. The
APC will also be constant only if
the consumption function
passes, through the origin.
When it does not pass through
the origin, the APC will not be
constant.
• As income rises, the MPC also
falls, but it falls to greater extent
than the APC.
• As income falls, the MPC rises.
The APC will also rise but at a
slower rate.
 Comparative view of values of all of them:
Value APC APS MPC MPS
Negative (less than No, due to presence Yes, when C >Y, i.e. No, as can never be more No, as ∆C can never be
0) of c before BEP. than ∆Y. more than ∆Y.

Zero No, due to presence Yes, when C =Y, i.e. Yes, when AS = ∆Y Yes, when AC = ∆Y
of c at BEP.

One Yes, when C = Y, No, as savings can Yes, when AC = ∆Y Yes, when AS = ∆Y
i.e. at BEP. never be equal to
income.

More than One Yes, when C >Y, i.e.No, as savings can No, as ∆C can never be No, as ∆S can never be
before BEP. never be more than more than ∆Y. more than ∆Y.
income.
 Consumption Function

• The consumption function, or Keynesian consumption function, is an economic

formula that represents the functional relationship between total consumption
and gross national income. It was introduced by British economist John Maynard
Keynes, who argued the function could be used to track and predict total
aggregate consumption expenditures.

C = a + bY
• Where, C = Consumption
a = Autonomous Consumption
b = Induced Consumption or Marginal Propensity to Consume
Y = Income Level
 Consumption Function
•The consumption function relates to the
amount of consumption to the level of
income
•Consumption function or propensity to
consume refers to income consumption
relationship that is
•C =f(Y),if Y increases, C increases and if Y
decreases C decreases
 Consumption Schedule

Income Consumption
(Y) C = f(Y)
S’

Consumption
0 20
C
C2
60 70 (C=Y) S
C1
120 120 B

180 170
240 220 45o
O
Y1 Y2 Income
300 270
360 320
 Average Propensity to Consume(APC)
• The relationship between income and consumption
is measures by average and marginal propensities
to consume.
• Average propensity to consume (APC) refers to the
total amount of consumption expenditure out of a
given total income at a point to time. It is expresses
as the ratio of total consumption to total income.
• APC = (Total Consumption/Total Income) = C/Y
 APC

Consumption

B ć
A
C2
C1

Income
O Y1 Y2
Marginal Propensity to Consume(MPC)
• The marginal propensity to consume (MPC) is
the ratio of change in total consumption and
total income. if consumption changes by ∆C in
response to ∆Y change in income, the
marginal propensity to consume would be ∆C/
∆Y
• MPC = Change in consumption / change in
income = ∆C/ ∆Y
 MPC

Consumption

B ć
A ∆C

R
C ∆Y

Income
O Y1 Y2
 Propensity to Save – Average Propensity to Save (APS)
• The average propensity to save (APS) and the marginal
propensity to save (MPS) are related to income in a way
similar to APC and MPC. The average propensity to save (APS)
is the ratio of total savings (S) to total income (Y). Since
income is either consumed or saved
C+S =Y
[(C/Y) + (S/Y) = (Y/Y)]
APC + APS =1 APC = 1 - APS APS = 1 – APC
 Propensity to Save – Marginal Propensity to Save(MP
• The marginal propensity to save (MPS) is the ratio of the
change in total saving to the change in total income.
Symbolically.
• MPS = (Change in Saving/ Change in Income) ∆S/ ∆Y
C+S=Y
So,∆C + ∆S = ∆Y
[(∆C/ ∆Y) + (∆S/ ∆Y) = (∆Y/ ∆Y)]
Or,MPC + MPS = 1
• MPC = 1 – MPS, and
• MPS = 1 - MPC
 (1) (2) (3) (4) (5) (6)
Income Consumption APC = C/Y APS = S/Y MPC = MPS =
Y (C) (1- APC) ∆C/ ∆Y ∆S/ ∆Y
(1-MPC)

120 120 120/120 = 1 0 _ _

or 100%

180 170 170/180 = 0.08 50/60 = 0.17

0.92 or 92% 0.83

240 220 220/240 = 0.09 50/60 = 0.17

0.91 or 91% 0.83

300 270 270/300 = 0.10 50/60 = 0.17

0.90 or 90% 0.83

360 320 320/360 = 0.12 50/60 = 0.17

0.88 or 88% 0.83 or
83%
 Psychological Law of
Consumption (Keynes)
There is a tendency on the part of the people
to spend on consumption less than the full
increment of income
Proposition ;
1.When income increases consumption expenditure also
increases but a smaller amount.
2.The increased income will be divided in some proportion
between consumption expenditure and saving.
3.Increase in income always leads to increase in both
consumption and saving.
 Prposition1 Proposition 2 Proposition 3
Income Consump Savings
(Y) tion © (S=Y-C) • Income increases • The increased • With the increase
by 60 crores income of 60 in income neither
• Consumption crores in each consumption nor
increases by 50 case in some saving have fallen
0 20 -20 crores proportion
• As Y increases C between
Increases consumption and
saving
60 70 -10 • 50 crores and 10
crores
120 120 0

180 170 10 C,S

240 220 20 A2 45ᵒ

A1 Saving Gap
300 270 30 B
C1 C2
360 320 40 Consumption

Income
O Y0 Y1 Y2
 Prposition1 Proposition 2 Proposition 3
• Income increases • The increased • With the
by 60 crores income of 60 increase in
• Consumption crores in each income neither
increases by 50 case in some consumption nor
crores proportion saving have
• As Y increases C between fallen
Increases consumption and
saving
• 50 crores and 10
crores
 Assumptions of Law
• Stable Institutional and Psychological Factors
• Normal Conditions
• Laissez Faire Economy
 Forms of Consumption Function
• Linear Consumption Function
• Non-Linear Consumption Function
 Consumption Function
C = a + bY (‘b’ is MPC)
C= Autonomous Consumption + Induced Consumption
Y

1000

Consumption (Rs. Crores)

800

600

400 bY

200
C a
O X
200 400 600 800 1000
Income (Rs. Crores)
 Non-Linear Consumption Function
Diminishing propensity to Consume
Y
C
∆C4
∆C3
∆C2
∆C1

Consumption (C)
C

∆Y1 ∆Y2 ∆Y3 ∆Y4

O X
Income (Y)
 Cyclical Consumption Function

• It is very difficult to determine the behaviuor

of consumption over a period of time
• Keynesian’s psychological law of consumption
is that in the short period (Cyclical) the
consumer don’t spent the entire increment of
income and MPC<1
• In the short period, the consumption function
is stable i.e there is no shift in the
consumption function
 Secular Consumption function
• In the long period (Secular) shape, position
and slope of the consumption function
changes on account of certain dynamic
influences like the population growth, changes
in the capital stock, inventories etc.
 Reasons:
• In the short period of time, there is not enough time
for consumption to adjust itself with income, so that
when income rises, consumption does not rise to the
same extent and when income falls , consumption
does not fall to the same extent i.e consumption
always lags behind
• Historical experiences and research in business
studies have been established that the secular trend
of consuption moves more and less in proportion to
the rise in income.
Questions???

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 References

• D.N. Dwivedi, “Managerial Economic”, Vikas Publications, New Delhi.

• D. Salvatore, “Microeconomic Theory”, Tata McGraw Hill.
• D.M. Mithani, Managerial Economics Theory and Applications, Himalaya Publication, Bangalore.

• Mankiw Gregory N. (1998) : Principles of Economics, 3rd Edition, Thomson, 3rd Indian Reprint (2007).

• Pindyck, Robert S., Rubinfel : Micro-Economics, Prentice Hall of India, New Delhi.

• Daniel, L. and Gupta, P.L. (2006) 3. Maddala, G.S. and Miler Ellen : Micro-Economic Theory and Applications

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 REFERENCES
• Dwivedi D.N. , Managerial Economic, Vikas Publications, New Delhi.
• Mithani D.M. , Managerial Economics Theory and Applications, Himalaya Publication, Mumbai.
• http://www.economicsdiscussion.net/production-function/production-function-meaning-definitions-and-features/6892
• https://www.toppr.com/guides/economics/production-and-costs/production-function/

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 THANK YOU

For queries
Email: [email protected]

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