Econotes 9 – Consumption and Investment

For TE2, TI3, and TJ3

According to a “Nations that save and invest large fractions of their incomes tend to have rapid
study, one of growth of output, income, and wages”
the differences In contrast
between the “Nations that consume most of their incomes have obsolete capital, low
rich and the educational standards, and backward techniques…”
poor is their
level of It can be implied that, “high consumption relative to income spells low
patience in investment and slow growth; high saving leads to high investment and rapid
terms of growth”
consumption
Consumption Consumption (aka personal consumption expenditures) is expenditure by
households on final goods and services.
Consumption function shows the relationship between the level of
consumption expenditures and the level of disposable personal income, or

consumption (c )=C 0−b (Y −T ), alternatively we could have

consumption(c )=C 0−cY

Where C 0 is the autonomous consumption not influenced by income

DI is income less taxes, Y −T =DI
Income = wages, transfer payments, interests, rents, dividends, etc.

Budgetary  Poor families must spend their incomes largely on necessities e.g., food and
expenditure shelter.
patterns  As income increases, expenditure on many food items goes up
 As there are limits to the extra money people will spend on food when their
income rise, hence, the proportion of total spending devoted to food declines
as income increases.
 Spending on luxury items increases in greater proportion than income
 Income is the primary determinant of consumption and saving
 Rich people save more than poor people, both absolutely and as a percent of
income

2012 Income Class (in thousands pesos [‘000])

Category of consumption All < 40 40- 59 60- 99 100 - 249 250 <
Food (outside) 42.8 62.3 62.2 60.1 51.8 34.9
Alcoholic Beverages 0.6 0.9 0.9 0.9 0.8 0.5
Tobacco 0.9 1.5 1.6 1.5 1.2 0.6
Clothing & Footwear 2.4 1.7 2 2 2.1 3.3
Furnishings 2.8 2 2 2 2.1 4.4
Health 3.7 10.6 18.5 17.5 20 21.5
Utilities 20.7 20.6 18.5 17.5 20 21.5
Transportation 7.5 3.1 3.6 4.5 6.4 8.7
Communication 2.7 0.4 0.8 1.2 2 3.4
Recreation and culture 1.4 0.3 0.5 0.7 0.9 1.8
Education 4.1 0.4 0.8 1.6 2.6 5.4
Accommodation services 0.2 0.1 0 0.1 0.1 0.2
Misc goods and services 6.6 3.6 4.3 4.7 5.7 7.5
The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.
 Others 3.7 0.9 0.8 0.9 1.5 5.4
*Source: FIES, 2012

Income Class Disposable Income ($) Net saving/ dissaving ($) Consumption ($)
A 24,000 -200 24,200
B 25,000 0 25,000
C 26,000 200 25,800
D 27,000 400 26,600
E 28,000 600 27,400
F 29,000 800 28,200
G 30,000 1000 29,000
*How much of each extra dollar of income do people devote to extra
consumption? How much to extra saving?

Breakeven point is the level of disposable income at which the households just
break even, or the level of disposable income is equal to consumption level
Saving Personal saving is the part of disposable income not used for consumption
Saving function shows the relationship between the level of saving and the level
of disposable personal income, mathematically,

saving(s)=disposable income ( DI )−consumption( c)

Where disposable income is income less taxes, Y −T =DI
Income = wages, transfer payments, interests, rents, dividends, etc.

For example,

Items Amount, 2007

Personal Income 11,663
Less: Personal taxes 1,493
Equals: Disposable Income (DI) 10,171
Less: Personal outlays 10,113
Equals: Personal saving (s) 57.4
Saving as % of DI .6

Marginal  MPC is the extra amount that people consume when they receive an extra
propensity to dollar (peso) of disposable income, where marginal means, as before,
consume (MPC) additional and propensity to consume means the desired level of
The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.
 consumption.
*show how to derive MPC from table of consumption and saving

 Note that whenever we are referring to the “marginal,” we refer to the slope
∆Y
of the function as well. Remember that the slope is the , or in the
∆X
∆∈consumption
consumption function, the slope is the or b.
∆∈income
Marginal  MPS is the fraction of an extra dollar of DI that goes to extra saving, or we can
propensity to say that, mps ≡1−mpc
save (MPS)  Therefore, the total of mps and mpc must ALWAYS equate to 1.
Determinants 1. Disposable income
of consumption 2. Permanent income – consumption primarily responds to permanent
changes income
3. Life-cycle model of consumption – people save in order to smooth their
consumption over their lifetime
4. Wealth and other influences / wealth effect – the higher wealth leads to
higher consumption
Investment Additions to the stock of productive assets or capital goods like computers or
trucks
Total social investment: foreign investment, government investment, intangible
investments in human capital and improved knowledge
Determinants of investments:
1. Revenues – will pursue investment if the investment will bring additional
revenues higher than the cost of investment
2. Costs – the interest rate (cost of borrowing) is lower than the stream of
benefits that will be derived from investment
3. Expectations
Investment demand curve
Shows the relationship between the interest rates and investments. The curve is
downward sloping because as the interest rate declines, more investment
projects become profitable.
READ
Shifts in the investment demand curve
READ
National  We now scale up the individual consumption behavior to the national
consumption consumption because it is crucial for understanding both short-term and
behavior business cycles and long-term economic growth.
 Drastic changes in C lead to changes in output and employment through the
impact on AD. Remember that AD=C+ I +G
 Whatever that is not consumed must be saved i.e., it is available for
investment in new capital goods and capital serves as a driving force behind
long-term economic growth.

The Econotes are heavily drawn from Economics (19 th Ed.) by Paul Samuelson and William Nordhaus. This serves only as
a supplementary reviewer for the Economics 11 students under TE2, TI3, TJ3 (1 st Sem AY 2014-2015) and must not be
considered as a complete alternate to Samuelson’s Book. Note that this document is still a work in progress and may
contain unnoticed errors. Students are expected to exercise due diligence in reviewing the notes and encouraged to do
necessary corrections.