Consumption- the expenditure of goods or services
whether you consume it or not, as long as you pay for it.
Formula:Y d =C+S
Derived Formula: C=Y d -S
Where:Y d = Disposable income (income after tax and
transfer payment)
C= Consumption
S= Savings
Household Consumption- it is the amount of final
consumption expenditure to meet their everyday need.
(e.g. Food, Clothing and Shelter)
Business Consumption- business activity provide
households with economic income to meet consumption
expenditures as periodic payments for society’s current
consumption of social goods.
DETERMINANTS OF CONSUMPTION
1. Distribution of National Income-When income
is equally distributed, then many will have the
opportunity to consume. Therefore, the
consumption is high.
2. Interest Rate-A high interest rate encourages
people to save and consume less.
3. Price Level-During inflation when price are
high people tend to spend more
4. Desire to hold cash-For some personal business
reasons, some people desire to hold cash,
thereby decreasing consumption.
5. Population-A high population makes more
people to buy goods and services.
6. Distribution of National Income-When income
is equally distributed, then many will have the
opportunity to consume. Therefore, the
consumption is high.
7. Interest Rate-A high interest rate encourages
people to save and consume less.
8. Price Level-During inflation when price are
high people tend to spend more
9. Desire to hold cash-For some personal business
reasons, some people desire to hold cash,
thereby decreasing consumption.
10. Population-A high population makes more
people to buy goods and services.
11. Income-High income implies more
consumption.
12. Taxes-More tax on income reduces disposable
income, thereby decrease in consumption.
13. Attitude and values-People’s attitudes and
values over cash can influence consumption.
Those who are typically thrifty have lower
consumption while does who are extravagant
naturally have higher consumption.
Marginal Propensity to Consume (MPC)-a change in
the income result to changes in the consumption. It is the
slope of the consumption function.
C2−C 1 ∆C
MPC= or MPC=
Y d −Y d
2 1
∆Yd
Marginal Propensity to Save (MPS)-a change in the
income can affect savings. It is the slope of the saving
function.
C2−C 1 ∆S
MPS= or MPS=
Y d −Y d
2 1
∆Yd
Consumption Function- is an economic formula that
connects consumption and income. “The higher the
income, the higher also is the consumption and vice
versa.”
Formula: C=A+bY
Where: C= Consumer Spending
A= Consumption
b= Marginal Propensity to Consume
Y= Disposable Income
Two Noteworthy Features of Consumption Function
1. A zero or very low level of income,
consumption expenditure is higher than income
as minimum consumption is necessary for
survival;
2. As income increases, consumption expenditure
also increases but increase in consumption is
less than the increase in income.
Average Propensity to Consume- this is defined as the
proportion of income that is consumed or how much a
person spend on average.
C
APC=
Yd
Average Propensity to Save- it is defines as the
proportion of income that is saved.
S
APS=
Yd
Savings- It is the income received by a consumer that is
not spent on the output of firm to consumption
expenditure.
Determinants of Savings:
1. Part of National Income- it is available for
spending goes to savings which is inversely
related to the corresponding level of
expenditure.
2. Price Level- savings available for investment
declined considerably and pushed the official
interest rate to an unprecedented level.
3. Population Growth- may change the level of
savings depending on the well-being of the
economy. An economy experiencing rapid
population growth may be forced to save by
sacrificing superfluous consumption.
Factors Affecting Savings:
1. The level of the real interest rate- a rise in
interest rate increases the value of households’
assets and can therefore lead to reduced
tendency to save.
2. The level of per capita GDP- very low-income
earners utilize all their income in order to
purchase the most basic commodities. Higher-
income earners are able to purchase luxury
goods and set aside some of their income for the
purpose of savings.
 3. Fiscal Policy- According to the economic theory
known as the Ricardian equivalence, a decline in
public savings will be offset by a rise in private
savings.
4. The proportion of labor remuneration in national
income- if in a given year and individual’s
income increases due to a rise in his wages,
private consumption will increase (and private
savings rate will decrease) more than in the case
of an identical rise in earnings deriving from
growth in income from property.
5. The distribution of income- The lower a
household’s income, the higher will be the
proportion of this income utilized for
consumption and the smaller will be the
proportion allocated to savings, and vice versa.
6. Financial reforms- usually have a temporarily
adverse affect on savings rates.
7. Uncertainty- whether political, economical or
personal, will generally have the effect of
encouraging all economic units to increase their
savings.
8. The effects of taxation- reducing private savings
while increasing government revenue and
savings.
9. Demographic factors- the life cycle model,
whereby savings are used for retirement and are
accrued at different rates during the individual’s
lifetime.
10. Pension plans- the effect of pension schemes on
the rate of savings is structural in nature.
Savings Function- is considered as the mirror image of
the consumption function.
S=Y d -C
Two Noteworthy Features of Savings Function
1. Savings can be negative at zero or low level of
income.
2. As income increases, savings also increase but
more than the increase in income.
The Multiplier- It is defined as the change in income to
the permanent change in the flow of expenditure that
caused it.
1
Multiplier=
1−MPC
Because MPS+MPC=1, MPS=1-MPC. It follows,
therefore, that the multiplier is equal to:
1
Multiplier=
MPS