CHAPTER 5

Aggregate Consumption and Saving

 Chapter outline
 Meaning and concept of consumption.
 Consumption Function.
 Keynesian Psychological Law of Consumption
 Determinants of Consumption Function.
1. Subjective consideration and
2. Objective consideration.
 Saving function or propensity to save
 Average Propensity to Consume
 Marginal Propensity to Consume
 Concept to Consumption
 That part of consumers disposable income which is
used to spend on the general utilization of goods and
services is by definition called consumption.
Generally income can be divided into two parts,
consumption and saving thus it can be shown as..
Y=C+S
C shows aggregate consumption which involve both
all private as well as government consumption
expenditures in a country.
Propensity to consume or consumption
function
 Consumption functions is a positive or direct
relationship between consumers disposable
income and consumption. In other words,
consumption function indicates that
consumption of consumers depend on their
level of income, more is the income, higher
will be the rate of consumption and vice
versa. Consumption function is also known as
propensity to consume which is shown as..
 C = f (Y)
 Two concept of consumption
function

An American economist J.M Keynes developed

two concepts for propensity to consume or
consumption function these are..
1. APC or ( Average Propensity to Consume) and
2. MPC or ( Marginal Propensity to Consume)
APC or Average Propensity to Consume

 Average propensity to consume (APC) is

defined as a ratio of total consumption to total
disposable income at different levels. It is calculated
by dividing the amount of consumption by disposable
income for any given level of income. For example,
when nation's disposable income is Afs. 2000 billion
and consumption expenditure is Afs. 1500 billion
therefore, 1500/2000 = 0.75. this means that out of
2000 billion income , 75% will be used for
consumption. APC declines as income increases
because the proportion of income spent on
consumption decreases as people tend to save more
out of increased income.
 APC = C/Y
 Marginal propensity to consume or (MPC)

 The concept of MPC is very important in

macroeconomics , J.M Keynes has defined
marginal propensity to consume “ as the
relationship between a change in
consumption (ΔC) that resulted from a
change in disposable income (ΔY). It is found
out by dividing change in consumption to a
given change in disposable income. MPC
shows that how much of change in income is
being consumed. Thus
MPC = ΔC/ ΔY
 Tabular explanation of APC and MPC
Income (Y) Consumption (C ) Saving APC = C / Y MPC = ΔC / ΔY

100 100 0 1 0

200 150 50 0.75 0.5

300 200 100 0.66 0.5

400 250 150 0.645 0.5

 Concept of Saving
 That part of households income which is not
spent on consumption is defined as saving. In
other words, saving is the act of not
consuming all of one's current income or
whatever is not consumed out of disposable
income is called saving. The economy's
saving equation is
 Saving = Disposable income – consumption
or
S=Y–C
 Motive for saving
 The motive for saving is divided into two
major consideration..

1. Subjective considerations.
2. Objective consideration.
 Subjective considerations
 Foresight : people save money as a
provision against some unforeseen
circumstances which might arise in the future.
A few other accumulate wealth for their
dependents, all such consideration can be
constituted under the heading foresight.
 Social considerations: wealth gives power
over others in the economic sphere and also
political and social influence. The desire of
prestige, power and respect in social life
actuates human being to save.
 Objective considerations.
 Security of life and property: if there is
security of life and property in a country, the
saving is encouraged.
 Facilities for investment: if facilities of
profitable investment are available, then
saving is stimulated.
 Saving function
 Saving function or propensity to save is the
direct or positive relationship between saving
and disposable income of individuals. In other
words saving is the function of income, as
much as income is increasing saving will also
tend to increase and vice versa. Both
consumption and savings are positively
correlated with the levels of income. Higher is
the income, more will be the tendency for
consumption and saving. Thus
 S = f (Y)
 Concepts of saving function.

 APS ( Average Propensity to save )

 MPS or ( Marginal Propensity to save )
CONT`D
 Average propensity to Save (APS): the ratio of
savings to income
APS = S / Y
 Marginal propensity to Save: the ratio of
change in saving to change in income.
MPS = change in saving/ change in income

Note : MPC + MPS = 1

Keynesian Psychological Law of Consumption

 J.M. Keynes in his book “ General Theory” analyzed the

consumption behavior of the community on the basis of
human behavior. He presented a Law which is known as
Psychological Law of Consumption.
 According to this Law, the level of consumption in a
community depends upon the level of disposable income,
as income increases, consumption also increases but at
a decreasing rate or it increases not as fast as income.
 According to J.M. Keynes that as a psychological
behavior of people the increase in consumption is less
than the increase in income and this is what given as a
Psychological Law of consumption.
Properties to the Law of Consumption
 The level of consumption is directly functionally
related to the level of disposable income.
C = f ( Y ).
 The rise in the level of consumption is less than the
rise in the level of income or consumption is
increasing but at decreasing rate.
ΔC < ΔY.
 As the level of income increases, the household s
devote a part of incremental income to increase in
consumption and the other part to increase saving.
Symbolically
ΔY = ΔC + ΔS