Consumption Function
Consumption Function
• Assumptions:
• APC=C/Y
• MPC= ∆C/∆Y=
• APS=S/Y
• MPS= ∆S/∆Y
• C= Total consumption
• Y=Total Income
• S=Savings
• The marginal propensity to consume (MPC) is the
extra amount that people consume when they
receive an extra unit of income.
MPC = ΔC / ΔY
Household Consumption and Saving
C = a bY
• The slope of the
consumption function (b) is
called the marginal
propensity to consume
(MPC), or the fraction of a
change in income that is
consumed, or spent.
0 b<1
Household Consumption and Saving
MPC+MPS 1
• Once we know how much consumption will
result from a given level of income, we
know how much saving there will be.
Therefore,
S YC
An Aggregate Consumption Function
Derived from the Equation C = 100 + .75Y
C 100 .75Y
• At a national income of
zero, consumption is
$100 billion (a).
• For every $100 billion
increase in income (DY),
consumption rises by
$75 billion (DC).
Savings
CA S = f(Y)
45˚
0
YE Y
-CA
APC and MPC: the relationship between Y
and C is measured by APC and MPC
APC MPC
• Measures the incremental change in
• Is a relationship consumption C as a result of a given
between total C increment in come (Y)
and Y in a given • But MPC = the ratio of change in
time period. consumption to the change in income.
• In otherwords APC
= C/Y. DC
MPC
DY
• ∆C: Incremental change in consumption.
• ∆Y: Incremental change in income
• The normal relationship between Y and C is
such that when y increases C also increases
but by less than the increase in income. In
normal times MPC is less than 1.
• It is drawn as a straight line
with a slope of less than one.
• This slope indicates the
percentage of additional
income that will be spent.
• If it is less than one bcz it is
assumed that the whole
additional income is not spent.
Certain percentage is spent
and remainder is saved
Y C S
100 75 25
120 90 30
140 105 35
180 135 45
220 165 55
Y C S APC=C/Y APS=S/Y MPC MPS
1000 950 50 0.95 .05 - -
1100 1040 60 0.94 0.06 90/100=0.9 10/100=0.1
1200 1125 75 0.93 0.062 85/100=0.85 15/100=0.15
1300 1205 95 0.92 0.073 80/100=0.80 20/100=0.2
1400 1280 120 0.91 0.093 75/100=0.75 25/100=0.25
The Consumption Function
C
Savings
Consumption
function C = f(Y)
CA Consumption
45˚
0 Y1 Y2 Y
The Consumption Function