GROUP 3 MACROECONOMICS ASSIGNMENT

MEMBERS:

1. Faith Wanjiru

2. Ammy Wanjiku

3. Shariff Mutama

4. Brian Mwangi

QN 1: What is consumption function?

This is the relationship between consumer spending and various factors determining it.
These factors include income, wealth, interest rate, riskiness of future income, and family size.

It is also an economic formula that directly connects the total consumption and gross national
income.

QN 2: Why is consumption important?

Consumption means the direct and final use of a good and services in the satisfaction of human
wants.

5. It is thebeginning of all economic activities.

A person feels a desire and then makes an effort to satisfy it. When the effort has been made the
result is the satisfaction of the want. As we have said, consumption also means satisfaction of
human wants. e.g,

farmers plough the land and produce goods, laborers work in the factory to produce goods.

All these are done to get satisfaction from the consumption of goods.

b. It is the end of all economic activities.

Suppose a person is hungry and starts preparing a meal, economic activities begins with it.After
preparing the meal, he or she consumes it. All economic activities which were started with the
preparing of the meal comes to an end.

c. It is the index of standard of living.

The consumption pattern of a person that is,what he eats, wears, in which type of a house they
live, etc, gives us the knowledge of the standard of living of the person.

d. Source of production.

According to Adam Smith, consumption is the sole purpose of all production. Production
increases with increase in consumption. It is consumption of goods that necessitates their
production.

e. Important in economic theory.

The study of consumption has contributed much in the formulation of certain economic
principles. eg.law of diminishing marginal utility which states, the more of an item you
consume or use, the less satisfaction you get from each additional unit consumed or used.

Law of demand which states, when price of a good increases, demand decrease and the
opposite is true.

f.important for the government.

The government formulates its economic policies on the basis of consumption habits of the
people.Minimum wages and the imposition of taxes are determined by the government
considering the consumption requirement of the public. From the consumption pattern of the
public, the government is able to know the produ8ction of essential and non-essential
commodities in the country.

g. Important in income and employment theory.

Keynes states that: if consumption does not increase, demand of goods will decrease and the
productin will fall. it may lead to unemployment.

A decrease in production means business will lay off workers resulting to unemployment.
Consumption thus help determine income and output in an economy.

QN 3: Explain the determinants of consumption.

a).Income

Income level is the most important factor of consumption as it directly affects the spending
capacity of an individual or household. When disposable income increases the demand for goods
and services also increase.\

This motivates manufacturing to ramp up to meet the demands creating more employment and
consumption in the economy.

Disposable income is the average income minus taxes. However, if demand increases but
manufacturers do not increase supply of goods and services, it leads toi a rise in price which
creates inflation.

Inflation refers to the persistent increase in price of goods and services in an economy .

b). Savings

When savings are low, it could mean that households are opting for a short term consumption
over long-term investment.

for example in the UK, Arise in savings lead to a fall in spending which ultimately became an
important cause of recession in 2008-2009.

Recession is a phase when there is a general decline in economic activities like production
consumption.

c). Expectations

Consumption could increase if there is an expectation of growth in income/household income. If

individuals are confident, they are more likely to spent now.Incase consumers are pessimistic
about the future and expect inflation to be high, they will buy more goods and services now to
avoid future price rise.
d). Changes in fiscal policy

This is the use of government revenue collection/taxation and expenditure to influence the
country`s economy. This can also contribute to a change in consumption levels.

e).Debt

It can be said that household debts boost consumption growth in the shortrun as it assists to
increase the purchasing ability of the household through credit expansion.

However in the longrun, it can prove to have a neegative effect on growth. When consumers are
in debts or pay bigger instalments to repay their debts, it is unlikely their ability to consume will
change or rise.

e).Availability of goods and services

Inclination to consume can also be affected by the availability of substantial goods and services.
When goods and services are available in abundance, it could lead to more consumption, while a
crunch in it can lead to a decline.

QN 4: Explain Keyne`s psychological law.

It is popularly know as Keynessian law of consumption.

According to the law, as income increases consumption also increase but at a lesser rate than
the rise in income.

With minimum income, we fulfill our basic needs. However with zero income, our basic
neccesities are fulfilled either by borrowing or using our savings. This consumption is called
Autonomous consumption.

Whether income of a person increases, consumption also increase but at a lesser rate and apart of
the income is saved.

so simply, as income increases rate of saving increase.

example:

aggregate income(Y) consumption (C) savings(S)

Y C Y-C

0 500 -

1000 1300 -300

2000 2000 0

3000 2600 400

4000 3400 600

5000 4100 900

In the above example, we see that at 0 income, there is some level of consumption (Autonomus
consumption) however savings are negative.

As income rises to 1000, consumption increases but savings are negative. At further, increase in
income, consumption and income are equal and there is no saving.

However, we see tha as income increases by 1000 at each level consumption also increases but
less than the increase in income and savins also increase.

The two important properties of this law is:

As income increases, consumption increase but at a lesser rate than increase in income.

As income increases savings increase at an increasing rate.

QN 5:Differentiate between autonomous consumptoin and induced consumption using

consumption function.

i).Autonomous consumption.
This reffers to consumption incured by an entity on goods and services independent of income
level.

Also, it is the consumption expenditure that occurs when income level is 0. It ensures the basic
standards of living e.g spending on essential expenses like food, rent utilities, medicine and
interest obligations.

to calculate autonomous assumption, the following formula is used.

A.C= cunsumer spending-(marginal prospensity X disposable income)

example;

Suppose you have a spending of 500 and the marginal prospensinty to consume is 80% and the
disposable income 1500, calculate the autonomous consumption.

A= C-bY

Therefore,

A=500-(0.8 X 1500)

=sh 3800

From the consumption function which is

C= A +bY

A= C-bY

Where

C- Consumption function

A- Level of Autonomous consumption

b- Marginal prospensinty to consume out of income

Y-income
ii).Induced consumption

This is the portion of consumption that varies with disposable income. When a change in
disposable income "induces" a change in consumption on goods and services, then that changed
consumption is called induce consumption.

induced consumption= b X Yd

Where

b-marginal prospensinty to consume

Yd- Disposable income.

QN 6. Can Autonomous Consumption ever be zero? justify your answer

Autonomous consumption expenditure cannot be zero. Autonomous consumption is the

minimum expenditure which takes place irrespective of the income.

In other words, it is the basic consumption of the individuals when the level of income is zero.
such expenditure cannot be zero.