Consumption and Savings

The Circular Flow of Economic Activity Reflecting the

Outflows and Inflows
Economic Resources

Purchase of Goods and Services

HOUSEHOLDS

Producing Units
Income Payments of Wages, Rent,
and Interests
Goods and services

Imports

Foreign Countries

Taxes

Government

Savings

Banks

Exports
Expenditures
Investments

Inflows and Outflows

Consumption
The mainstream of the circular flow. But
households do not usually spend all of their
income.

Savings
Have the effect of decreasing the level of
economic activity in the flow.
1st constitute the first outflow from the stream.

Inflows and Outflows

When households pay taxes, the effect is to
lessen their disposable income and the
available amount available for
consumption spending

Consumption and Savings

Consumption
Is the act of using goods and services to
satisfy human wants
In the broader sense, it is not the monopoly of
households since businesses and the
government also use goods and services to
attain some ends

Consumption
Types:
1. Household consumption
Directly satisfies human wants
2. Business consumption
Indirectly satisfy human wants because it is the
business activities that provide the households
with economic income
*Consumption Expenditures

Periodic payments for societys current consumption

of social goods
Example: to help provide peace and order in
everyday life, the government spends for the
monthly salaries of policemen.

Consumption Function

1. Consumption and Income

2. The Multiplier Concept
3. Consumption and Savings
4. Graphical and Tabular
Illustrations

Consumption Function
1. Consumption and Income
Personal or household consumption is one of the
determinants of national or factor income.
If the assumption is that income is only equal to
consumption:
the inflow generates the income constitutes
borrowings from the economys stock of
savings.
Formula of Income (without the inflows of investment,
government spending and net exports):
Y = Cb + C where: Y = Factor Income
Cb = Borrowings from the
economys stock of savings
C = Change in consumption

Consumption Function

2. The Multiplier Concept

The process of generating
income through the circular
flow exchange between the
households and the firms

The Multiplier Coefficient

Measures the average number of times every

peso of inflow circulates and changes hands in
the system as income.
Measures the income generated from every
peso of inflow multiplied to the total inflow
yields aggregate income.
Formula:
Y = CbM
where additionally:
M = Multiplier Coefficient
(MPC) = Marginal Propensity to Consume
MPS = 1 (MPC) = Marginal Propensity to Save

The Multiplier Coefficient

Formula:
Y = CbM
M=
1-----1- (MPC)
where additionally:
M = Multiplier Coefficient
(MPC) = Marginal Propensity to Consume
MPS = 1 (MPC) = Marginal Propensity to Save
MPS + MPS = 1

The Multiplier Coefficient

Depends on the fraction of every additional

income generated in the exchange that flows
out as savings.

This outflow determines the portion left for

consumption to re-circulate and further generate
more income.

Marginal Propensity to Consume (MPC)

Consumption factor of the multiplier
Marginal Propensity to Save (MPS)
Savings factor
*both represents consumption and savings from
every additional peso of disposable income
that system generates.

The Multiplier Coefficient

Income is fully generated when the inflow has

been fully absorbed from the system in the
form of savings.
Savings gradually diminishes this inflow that
the system circulates and generates into
income.
Once income is fully generated, there is
nothing left for re-circulation

Consumption and Savings

Important things to remember:
1. The additional income that the system
generates by the multiplier process yields
savings outflow.

If income is generates through borrowings, the

savings outflow can be used for debt payments

*Generating more income means more savings

outflows to settle more debts and whatever the
economy owes to past accumulated savings.
*When income is fully generated, the debt balance
is reduced to zero.

Factors of Consumption
Personal consumption
Is households realized
demand to satisfy current
needs. But, it should not be
concluded that demand factors
are the only determinants of
consumption.

Factors of Consumption
Personal consumption
Is households realized demand to satisfy
current needs. But, it should not be
concluded that demand factors are the only
determinants of consumption. (income, taste
and preferences, size of population, price
level, innovation and promotion

Important points to remember:

1. Increase in consumption means more
income left in the circular flow which
multiplies to higher income levels.
2. Decrease in consumption affects the
multiplier negatively

Factors of Consumption
Important points to remember:
1. Increase in consumption means more
income left in the circular flow which
multiplies to higher income levels.
2. Decrease in consumption affects the
multiplier negatively