Unit-5

Syllabus
 What is
consumption?
• Consumption is the use of final goods and
services to satisfy needs (wants).

• Consumption is the process of satisfying human

wants.

• We make expenditure on goods and services

which are needed to meet our wants.
Consumption
Function
• A function showing how the relationship between consumption
and its determinants ( mainly income)

• Consumption function represents amount of consumer

expenditure made at a given level of income whereas the propensity
to consume is a schedule of consumer expenditure at various income
levels. Propensity to consume does not mean a mere desire to
consume, but the actual consumption that place or is expected to
take place out of varying amount.--------- K.K. Kurihara

• Consumption function is nothing more than a statement of the

relationship between consumption expenditure and income …R.G.
Lipsey.
Consumption Function

• The consumption function or propensity to

consume means the functional relationship
between total consumption and gross income.
Mathematically,
 CONSUMPTION FUNCTION

 Consumption refers to a particular amount of consumption

out of a given amount of income.

 Consumption function indicates the relationship between

consumption and income.

 Consumption function refers to different amounts of

consumption at different level of income.

 C = f (Y)
 PSYCHOLOGICAL LAW OF
CONSUMPTION

• According to the law, “when aggregate income

increases, consumption expenditure shall also
increase but by a somewhat smaller amount.”
 AVERAGE PROPENSITY TO CONSUME

• It is the ratio of consumption expenditures (C)

to disposable income (DI)

APC = C / DI
 Average Propensity to Save
• The average propensity to save (APS) is the
ratio of savings (S) to disposable income, or

APS = S / DI
Calculations?

APC=C/Y APS=S/Y

.75

.75

.75

.75

.75

.75

.75
 Marginal Propensity to consume
• Marginal Propensity to Consume is the
proportion of an increase in income that gets
spent on consumption.
• MPC varies by income level. MPC is typically
lower at higher incomes.
MPC is the key determinant of the
Keynesian multiplier, which describes the
effect of increased investment or
government spending as an economic
stimulus.
MPC
 MPS
• The marginal propensity to save (MPS) is the
portion of each extra rupees of a household’s
income that's saved.
• MPC is the portion of each extra dollar of a
household’s income that is consumed or
spent.
• Consumer behavior concerning saving or
spending has a very significant impact on the
economy as a whole.
Investment
 Investment

• According to Prof. Keiser, “When an increase

in investment is due to increase in current
level of income and production, it is known as
induced investment”.
• “Private investment refers to that investment
which is made by private individuals with the
sole objective of earning profit” “Public
investment is that investment which is made
by the central provincial or local-self
government of a country. The objective
behind such an investment is welfare of the
people”
• “The total expenditure incurred on capital
goods at any given time in an economy is
called gross investment” It includes two kinds
of investments:
• 1) Net investment
• 2) Replacement investment.

“Replacement investment is that

investment which maintains intact a
given stock of capital” “Net
investment is investment that
enlarges economy’s stock of real
capital assets thereby adding to
productive capacity
 Multiplier
• Multiplier broadly refers to an economic factor
that, when increased or changed, causes
increases or changes in many other related
economic variables.
• In terms of gross domestic product, the
multiplier effect causes gains in total output to
be greater than the change in spending that
caused it.
 KEY POINTS
• A multiplier refers to an economic factor that,
when applied, amplifies the effect of some
other outcome.
• A multiplier value of 2x would therefore have
the result of doubling some effect; 3x would
triple it.
• Many examples of multipliers exist, such as the
use of margin in trading or the money
multiplier in fractional reserve banking.