MODULE I: GENERAL PRINCIPLE

B. MACROECONOMICS:

2) Saving, Consumption and Investment

CONSUMPTION FUNCTION

After reading this unit you should be able to understand:

• What is a consumption function?

INTRODUCTION

✓ As the demand for a good depends upon its price, similarly consumption of a
community also depends upon the level of income.
✓ In other words, consumption is a function of income.
✓ Y=C+S Therefore, C=f(Y)
✓ The consumption function relates the amount of consumption to the level of
income.
✓ When the income of a community rises, consumption also rises.
✓ How much consumption rises in response to a given increase in income
depends upon the marginal propensity to consume (MPC).
✓ It should be kept in mind that the consumption function is the whole
schedule which describes the amounts of consumption at various levels of
income.

Consumption function should be carefully distinguished from the amount of

consumption. By consumption function is meant the whole schedule which shows
consumption at various levels of income, whereas amount of consumption means
the amount consumed at a specific level of income.

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SCHEDULE OF CONSUMPTION AND INCOME

INCOME (Y) CONSUMPTION (C)

100 70
120 80
140 90
160 100
180 105
200 110

The Aggregate Consumption Function

✓ Every individual or household has its own consumption function.

✓ The function shows how its desired consumption expenditure varies with its
income.

✓ By adding up the consumption functions of all households we arrive at the

aggregate consumption function.

✓ This is of interest to us in macro-economics. It shows how the total desired

consumption spending of all households varies with national income.

The aggregate consumption function reflects the behaviour of different types of

individuals. However, extreme fluctuations cancel each other out.

✓ When, for example, income rises, some very poor people may spend all of
the extra income, while some very rich ones may save all the extra income.

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 ✓ But since most people spend a portion of their extra income and save the
rest, the aggregate consumption function shows the same type of behaviour,
i.e., when national income rises there is an increase in both consumption and
saving.

J. M. Keynes first introduced the term ‘consumption function’ in 1936 to describe

the relationship between household’s planned consumption expenditure and all the
forces that determine it. In order to develop a theory we have to hold all the vari-
ables, except one, constant. This will enable us to study how consumption varies
with income.

On the basis of such study it will be possible for us to derive a simple relation
between consumption and income. This relation was called by J. M. Keynes the
consumption function and is expressed as:

C = f(Y)

Where,

C is consumption and Y is income.

This relation implies that consumption depends on income or is a function of

income. If there is a change in any other variable affecting consumption spending
there will be a shift of the consumption function.

The schedule described below reflects the consumption function of a community i.

e. it indicates how the consumption changes in response to the change in income.

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 TABLE 1: SCHEDULE OF CONSUMPTION FUNCTION

INCOME CONSUMPTION
1000 950
1100 1020
1200 1090
1300 1160
1400 1230
1500 1300
1600 1370

✓ In the consumption schedule given in Table 1 it will be seen that at the

level of income equal to Rs. 1200 crores, the amount of consumption
is Rs. 1090 crores.

✓ As the national income increases to Rs. 1500 crores, the amount of

consumption raises to Rs. 1300 crore, consumption function remaining the
same.

✓ Thus, with a given consumption function, amount of consumption is

different at different levels of income.

The above schedule of consumption function reveals an important fact that when
income rises, consumption also rises but not as much as the income. This fact
about consumption function was emphasized by Keynes, who first of all evolved
the concept of consumption function.

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 ✓ The reason why consumption rises less than income is that a part of the
increment in income is saved.

✓ Therefore, we see that when income increases from Rs. 1000 crores to Rs.
1100 crores, the amount of consumption rises from Rs. 950 crores to 1020
crores.

✓ Thus, with the increase in income by Rs. 100 crores, consumption rises by
Rs. 70 crores; the remaining Rs. 30 crores is saved.

✓ Similarly, when income rises from Rs. 1100 crores to Rs. 1200 crores, the
amount of consumption increases from Rs. 1020 crores to Rs. 1090 crores.

✓ Here also, as a result of increase in income by Rs. 100, the amount of

consumption has risen by Rs. 70 crores and the remaining Rs. 30 crores has
been saved. The same applies to further increases in income and
consumption.

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 FIG 1: KEYNESIAN CONSUMPTION FUNCTION

REFERENCES:

1. https://www.nber.org/chapters/c4403.pdf
2. https://www.youtube.com/watch?v=oDjH7CiIbMw&t=175s
3. PRINCIPLES OF ECONOMICS: DR SR MYNENI

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