CONSUMPTION

AND SAVINGS
• The discussion of income determination refers to
economic income which is earned through
economic activities.
• It can be national income as reflected in the
value of production or personal economic
income which the firms pay to the households in
exchange for factor contributions
• Consumption is the act of using goods and
services to satisfy human wants.
• In a broad sense, consumption is not the
monopoly of households since businesses and
the government also use goods and services to
attain some ends
• Household consumption directly satisfies
human wants; whereas business consumption
does indirectly in as much as business
activities provide the households with
economic income to meet consumption
expenditures as periodic payments for
society's current consumption of social goods
• From the foregoing broad concept of
consumption, this chapter narrows down to
personal (household) consumption
1. Consumption and Income
• Personal or Household consumption is one of the determinants of
national or factor income
• If income is assumed as only equal to consumption, the inflow that
generates the former constitutes borrowings from the economy’s stocks of
savings
• The following equations sum up the income components without the
inflows of investment, government spending, and net exports:
Y=𝐶𝑏 + ∆C
where:
Y = Factor Income
𝑐𝑏 = Borrowings from the economy’s stock of savings
DC = Change in cosumption
The economy dissaves by borrowing
from its stock of savings to meet
current consumption needs in the
absence of income.

This initial consumption expenditure, which is

a purchase of consumption goods, is also
the initial factor income that the system
generates as it totally flows back to the
households in exchange for factor
contributions.
2. The Multiplier Concept
• The process of generating income through the circular
flow exchange between the households and the firms is
called the multiplier
•The multiplier coefficient measures the average
number of times every peso of inflow circulates and
changes hands in the system as income. The following
equations illustrate:
Y = 𝐶𝑏 M
1 1
M= =
1 −(𝑀𝑃𝐶) 𝑀𝑃𝑆
Where additionally:
M = Multiplier coefficient
(MPC) = Marginal propensity to consume
MPS = 1- (MPC) = Marginal propensity to save
• The multiplier coefficient depends on the fraction of
every additional income generated in the exchange
that flows out of the system as savings
• The consumption factor of the multiplier is expressed
as a coefficient called marginal propensity to consume
(MPC) while the savings factor is called marginal
propensity to save (MPS)
• The denominator of the multiplier equation (1 – MPC) is actually
the MPS since,
MPS + MPC = 1
• Once income is fully generated, there is nothing left for re-
circulation and, thus, the multiplier process is completed
S=i
i = Y – DC
Where additionally:
S = Aggregate savings from the currently generated income
i = Inflow
• The second equation can be re-structured as (Y = i + DC)
• The multiplier equation can be restated as follows since it is also a
measure of the average number of times the inflow is duplicated as
income:
𝑌
M=
𝑖
• The second equation can be re-structured as (Y
= i + DC)
• The multiplier equation can be restated as
follows since it is also a measure of the average
number of times the inflow is duplicated as
income:
𝑌
M=
𝑖
• Reducing income to 1 with the same propensity to
save does not change the multiplier value and should
conform to the first coefficient presented as follows:
1
M=
𝑀𝑃𝑆
since:
1
MPS = 1 – MPC, ergo: M =
1−𝑀𝑃𝐶
• Once the point where (S = I) is reached, accumulated
savings outflow is just enough to pay for the said
borrowings which financed the inflow of initial
consumption
• Using the same savings concept, current income levels
before the point where inflow is equal to outflow (S =
I) yield dissaving's or net borrowings since their
accumulated outflows can hardly repay what has been
borrowed from the economy’s depleted stock of
savings. The opposite is true of income levels beyond
the said point as they yield accumulated outflows that
more than replenish the stock and generate net
savings.
The multiplier process is illustrated by the
diminishing difference between line y and c as the
income level increases on the graph.

The initial consumption of 100 is also the initial

factor income that the system. Generates as firms
pay back all personal consumption expenditure to
the households in exchange for factor contributions.

The symbol n represents an inifinitely small value

implying that nothing is left at this point to further
generate income.
1. Framework
•Personal consumption is household’s realized
demand to satisfy current needs. However, one
should not be misled to the conclusion that demand
factors are the only direct determinants of
consumption.
• Figure 36 illustrates that the consumption line
pivots upward to 𝐶2 wherein the same increase in
income yields greater consumption and marginal
propensity to consume
• Note that the initial increase in consumption in
Figure 36 from 500 to 550 causes a bigger leap
in equilibrium income from 500 to 1000.
• Income increases by 500 while consumption
increases by 400 from Points A to Point B giving
an MPC of 0.80 and multiplier of 5. a change in
consumption equal to 450 for the same increase
in income shifts the consumption line upward from
𝐶1 to 𝐶2 .The MPC and multiplier increase to 0.90
and 10, and the income level rises to 1000 from
the same inflow (initial consumption) of 100
2. Taste or Preference
• Taste or preference depends on how the product
satisfies one’s desires
• A change in collective attitude can change aggregate
taste or preference, consumption, and marginal
propensity to consume. However, a change in the
relative tastes or preferences of the population
according to consumption behavior can also alter
aggregate consumption with the same income.
• There are several underlying reasons why consuming
units have different attitudes toward consumption, and,
therefore, have different tastes or preferences
There are several underlying reasons why consuming
units have different attitudes toward consumption, and,
therefore, have different tastes or preferences
One reason is embodied in Duesenberry’s Relative
Income Hypothesis which states that the difference in
consumption behavior could be explained by the
difference in income level relative to what one is
accustomed to.
On the other hand, taste or preference may also
vary across different racial, ethnic, age, and
occupational groups
Finally, values have something to do with attitudes
and, therefore , affect taste or preference
4. Income
• The level of income can increase with
more infusions in the circular flow. As will
be shown in the succeeding chapters,
equilibrium income level varies along
line Y on the income graph depending
on the size of inflows and the
corresponding consumption level varies
directly along line C.
On the other hand, income distribution among
consuming units of different propensities to consume
also determines aggregate consumption. Therefore,
income re-distributed in favor of those with higher
propensity to consume increases the level of
aggregate consumption assuming other factors as
constant. This increase in aggregate consumption
subsequently multiplies into higher income levels.
• This is indicated as a pivotal movement of line C in
Figure 36 where marginal consumption varies from
the same increase in income and creates a multiplier
effect on the income level
6. Innovation and Promotion
• Innovation and promotion can expand
the line of consumers choice and extend
the influence of demand factors on
consumption and propensity to consume
income.
• The introduction of new products can
create demand and increase aggregate
consumption with the same taste or
preference and level of income
On the other hand, promotions and
advertising serve as a medium of
introducing new products in the
market which create demand and
consumption
• Thus, more advertising can change
this mix and influence consumption
expenditure from the same income
“ THANK YOU! “