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Consumption and household production

Consumption is defined in part by comparison to production. In the tradition of the Columbia School of
Household Economics, also known as the New Home Economics, commercial consumption has to be
analyzed in the context of household production. The opportunity cost of time affects the cost of homeproduced substitutes and therefore demand for commercial goods and services.[2][3] The elasticity of
demand for consumption goods is also a function of who performs chores in households and how their
spouses compensate them for opportunity costs of home production.[4]
Consumption is major concept in economics and is also studied by many other social sciences.
Economists are particularly interested in the relationship between consumption and income, as
modeled with the consumption function.

Different schools of economists define production and consumption differently. According to

mainstream economists, only the final purchase of goods and services by individuals constitutes
consumption, while other types of expenditure in particular, fixed investment, intermediate
consumption, and government spending are placed in separate categories (See consumer choice).
Other economists define consumption much more broadly, as the aggregate of all economic activity that
does not entail the design, production and marketing of goods and services (e.g. the selection, adoption,
use, disposal and recycling of goods and services).[citation needed]
Consumption function

Consumption function graph

In economics, the consumption function describes a relationship between consumption and disposable
income.[1] Algebraically, this means


is a function that maps levels of disposable

income after government intervention, such as taxes or transfer paymentsinto levels

of consumption

. The concept is believed to have been introduced into macroeconomics by John

Maynard Keynes in 1936, who used it to develop the notion of a government spending multiplier.[2] Its
simplest form is the linear consumption function used frequently in simple Keynesian models:[3]


is the autonomous consumption that is independent of disposable income; in other words,

consumption when income is zero. The term

economy's income level. The parameter

is the induced consumption that is influenced by the

is known as the marginal propensity to consume, i.e. the

increase in consumption due to an incremental increase in disposable income, since


is the slope of the consumption function. One of the key assumptions of Keynesian

economics is that this parameter is positive but smaller than one, i.e.


Criticism of the simplicity and irreality of this assumption lead to the development of Milton
Friedman's permanent income hypothesis, and Richard Brumberg and Franco Modigliani's life-cycle
hypothesis. But none of them developed a definitive consumption function. Friedman, although he got
the Nobel prize for his book A Theory of the Consumption Function (1957), presented several different
definitions of the permanent income in his approach, making it impossible to develop a more
sophisticated function. Modigliani and Brumberg tried to develop a better consumption function using
the income got in the whole life of consumers, but them and their followers ended in a formulation
lacking economic theory and therefore full of proxies that do not account for the complex changes of
today's economic systems.
Until recently, the three main existing theories, based on the income dependent Consumption
Expenditure Function pointed by Keynes in 1936, were Duesenberry's (1949) relative consumption
expenditure,[5]Modigliani and Brumberg's (1954) life-cycle income, and Friedman's (1957) permanent
Some new theoretical works are based, following Duesenberry's one, on behavioral economics and
suggest that a number of behavioural principles can be taken as microeconomic foundations for a
behaviorally-based aggregate consumption function.[7]