Consumption and Savings

Yogesh Bhawnani
 The Relationship Between
Income and Consumption
Disposable (after-tax) income equals
savings (S) plus consumption (C).

Economists define personal saving as “not

spending” or “that part of disposable
income not consumed.”
 The Consumption Schedule or
“Consumption Function”

In the aggregate, households increase their

spending as their disposable income rises
and spend a larger proportion of a small
disposable income than of a large
disposable income.
 Consumption Schedule

Income Consumption
0 20
60 70
120 120
180 170
240 220
 The Consumption Function

C
Savings
Consumption
function C = f(Y)

CA Consumption

45˚

0 Y1 Y2 Y
 The Consumption Function

• 45˚ line: at any point on the 45˚line

consumption exactly equals income and the
households have zero saving.
• MPC is the slope of the consumption
function, which measures the change in
consumption per unit change in income.
 Determinants of Consumption

• Current disposable income: it is the central factor

determining a nation's consumption.
• Permanent income: it is the level of income that
households would receive when temporary
influences are removed.
• Wealth: it is the net value of tangible and financial
items owned by a nation or person at a point of time.
• Other (interest rate, inflation, expectations).
 Savings

• Saving is that part of income that is not

consumed. Saving equals income minus
consumption: S = Y – C
• Income is the sum of consumption and
savings: Y = C + S
 The Saving Schedule or
“Saving Function”
There is a direct relationship between saving
and disposable income but saving is a smaller
proportion of a small DI than of a large DI.
Households consume a smaller and smaller
proportion of DI as DI increases; therefore,
they must be saving a larger and larger
proportion.
• Dissaving (consuming in excess of
after-tax income) will occur at
relatively low DIs.

• Households can consume more

than their incomes by liquidating
(selling for cash) accumulated
wealth or by borrowing.
 Savings

• The marginal propensity to save

S
MPS 
Y

is defined as the fraction of an extra unit of

income that goes to extra saving.
• MPC + MPS = 1 because the part of each
unit of income that is not consumed is
 The Consumption and Saving
Function

C, S
The saving
function is the
C = f(Y) mirror image of
the consumption
function. It shows
the relationship
CA S = f(Y) between the level
of saving and
45˚ income.
0
YE Y
-C
 Consumption and Savings Schedule

Income( Y) Consumption( C) Savings (S)

0 20 -20
60 70 -10
120 120 0
180 170 10
240 220 20
300 270 30
Marginal Propensity to Consume
(MPC)
The proportion, or fraction, of any change in income
consumed is called the marginal propensity to
consume (MPC). The MPC is the ratio of a change in
consumption to a change in the income that caused
the consumption change.

MPC = change in consumption

change in income
 Marginal Propensity to Save
(MPS)
The fraction of any change in income
saved is the marginal propensity to
save (MPS). The MPS is the ratio of a
change in saving to the change in
income that brought it about:

MPS = change in saving

change in income
 Marginal Propensities
How much of every additional dollar in income is
consumed? MPC
How much of every additional dollar iin income
is saved? MPS
MPC + MPS = $1 of additional income
.: MPC = 1 – MPS
.: MPS = 1 – MPC
Remember, people do two things with their
disposable income, consume it or save it!
 Criticism

 Proportional relationship between consumption and income is

not always true.
 It neglects other factors that influence , consumer spending
such as asset holdings, urbanisation, appearance of new
products, etc.
 Expectations and level of aspirations also play an important
role in consumer spending.