Consumption Function
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This document discusses the consumption function in economics. It defines key terms like income, disposable income, autonomous consumption, induced consumption, marginal propensity to consume, and average propensity to consume. It explains that consumption is primarily a function of disposable income and can be modeled as C = Y*MPC in the long run or C = ca + Y*MPC in the short run, where MPC is the slope of the consumption line. It also outlines Keynes' law of consumption, which states that increases in income lead to increases in both consumption and savings.
Consumption Function
- 1. Consumption Function Raju Indukoori Raju Indukoori
- 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. Raju Indukoori
- 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. Raju Indukoori 1
- 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 Raju Indukoori
- 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.. Raju Indukoori
- 6. Income Income can be summarized as follows Income (Y) = Consumption Expenditure (C) + Investment Expenditure (I) (or) Income (Y) = Consumption Expenditure (C) + Savings (S) Raju Indukoori
- 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. Raju Indukoori 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. Raju Indukoori 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. Raju Indukoori
- 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 Raju Indukoori
- 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. Raju Indukoori
- 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 Raju Indukoori
- 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 Raju Indukoori
- 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 Raju Indukoori
- 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. Raju Indukoori
- 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) Raju Indukoori
- 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. Raju Indukoori
- 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. Raju Indukoori
- 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) Raju Indukoori
- 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). Raju Indukoori
- 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 Raju Indukoori
- 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 Raju Indukoori
- 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) Raju Indukoori
- 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 Raju Indukoori
- 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 Raju Indukoori