Islamic Macroeconomics:

2. Consumption

Auwalin
Dept. Islamic Economics
Faculty of Economics and Business
Airlangga University
Today’s discussion
Why discussion on consumption is important?
Consumption in Islamic views
Hypothesis in consumption analysis:
Absolute Income Hypothesis (Hipotesa pendapatan
mutlak)
Relative Income Hypothesis (Hipotesa pendapatan relatif)
Permanent Income Hypothesis (Hipotesa pendapatan
permanen)
Life-cycle Hypothesis (Hipotesa siklus hidup)
Discussion on the effect of Zakat and Shadaqah on
consumption in each hypothesis
1. Calculating GDP: The Expenditure Approach
There are four main categories of expenditure:

Personal consumption expenditures (C): The

spending by households on goods and services, with
the exception of purchases of new housing.
Gross private domestic investment (I): spending by
firms and households on new capital, that is, plant,
equipment, inventory, and new residential structures

Government consumption and gross investment (G)

Net exports (EX - IM): net spending by the rest of the

world, or exports (EX) minus imports (IM)

GDP = C + I + G + (EX - IM)

Indonesia Gross Domestic Product at Constant Prices (Base
Year 2000), Expenditure Accounts
(Billion of Rupiah)
  2008** Percent
Consumption Expenditure 1,360,488
Private Consumption 1,191,191 57.2%
Government Consumption 169,297 8.1%
Gross Domestic Fixed Capital
Formation 493,222 23.7%
Change in Stocks (residual) 3,865 0.2%
Statistically Descrepancy 25,483 1.2%
Net Export 199,046 9.6%
Exports on Goods & Services 1,031,866
a. Goods 926,811
b. Services 105,055
Imports on Goods & Services 832,820
a. Goods 657,136
b. Services 175,685
GDP Total 2,082,104
Why consumption is important?
How do households decide how much of their income
to consume today and how much to save for the future?
microeconomic question (the behavior of individual
decision makers). Yet its answer has macroeconomic
consequences.
The consumption decision is crucial in determining
aggregate demand. In Indonesia, consumption is 60%
of GDP, so fluctuations in consumption are a key
element of booms and recessions.
Level of consumption affects level of saving: Y=C+S.
The saving rate is a key determinant of capital stock
and thus of the level of economic well-being.
Konsumsi dalam Ekonomi Islam
Kewajiban mengeluarkan zakat dan
pengeluran lain di jalan Allah.
Tidak menganjurkan:
Pola konsumsi yang boros
Pengeluran yang berlebihan
Efeknya: Konsumsi total akan berkurang 
tabungan meningkat  Investasi meningkat
 Kesejahteraan meningkat, ceteris paribus.
 Hipotesis dalam analisis konsumsi
Absolute Income Hypothesis (Hipotesa pendapatan
mutlak)
Relative Income Hypothesis (Hipotesa pendapatan
relatif)
Permanent Income Hypothesis (Hipotesa pendapatan
permanen)
Life-cycle Hypothesis (Hipotesa siklus hidup)
Consumption Catch-up Hypothesis (Hipotesa mengejar
konsumsi)
1. Absolute Income Hypothesis
 Keynes’s conjectures
Konsumsi dalam periode tertentu tergantung pada pendapatan
siap dikonsumsi (disposable income: C = C(Y − T)).
Pendapatan   Konsumsi , peningkatan C < peningkatan Y

1.0 < MPC < 1

marginal propensity to consume—jumlah yang dikonsumsi
dari setiap tambahan pendapatan sebesar1 Rupiah.
2.Average propensity to consume (APC )
falls as income rises.  (APC = C/Y )
3.Income is the main determinant of consumption.
 The Keynesian consumption function
C

C  C  cY

c c = MPC
= slope of the
1
consumption
C function

Y
Interpretations of C-bar:
• autonomous consumption: the portion of consumption that does not depend on
income
• the value of consumption if income were zero.
The Keynesian consumption function
As
As income
income rises,
rises, consumers
consumers save
save aa bigger
bigger
C fraction
fraction of
of their
their income,
income, so
so APC
APC falls.
falls.
C  C  cY

C C
APC    c
Y Y
slope = APC
Y
 Early empirical successes:
Results from early (cross-section) studies
Households with higher incomes:
consume more, confirmed that MPC > 0
save more, confirmed that MPC < 1
save a larger fraction of their income,  APC  as
Y

Very strong correlation between income and

consumption:
 income seemed to be the main determinant of
consumption
Problems for the
Keynesian consumption function
Based on the Keynesian consumption function,
economists predicted that C would grow more
slowly than Y over time.
This prediction did not come true:
As incomes grew, APC did not fall,
and C grew at the same rate as income.
Simon Kuznets showed that C/Y was
very stable in long time series data.
The Consumption Puzzle
Consumption function
C
from long time series
data (constant APC )

Consumption function
from cross-sectional
household data
(falling APC )

Y
 Islamic consumption function:
Effect of zakat on consumption function
C Z
C

C  C  cY

c
Cz
1

Y
Bagaimana pengaruh Zakat & sedekah dalam hipotesis
ini?
Redistribusi penghasilan (melalui zakat & berbagai
macam sedekah) akan meningkatkan konsumsi agregat:
Kelompok penerima zakat (yang miskin & yang
memerlukan) memiliki hasrat konsumsi (MPC) yang lebih
tinggi  sehingga slope lebih tegak.
Intersep (autonomous consumption) juga naik kewajiban
zakat & sedekah (bagi yang mampu) masuk sebagai
komponen konsumsi yang wajib.
Dalam model Islam investasi yang diperlukan untuk
menutup kesenjangan antara pendapatan dengan
konsumsi menjadi lebih kecil
2. Relative Income Hypothesis
 Irving Fisher and Intertemporal Choice
Menjadi dasar dari banyak analisis konsumsi yang berikutnya.
Mengasumsikan konsumen mempertimbangkan konsumsi pada
periode berikutnya (forward-looking) dan menentukan
konsumsi pada saat ini dan pada masa depan untuk
memaksimumkan tingkat kepuasan selama hidupnya.  selalu
berusaha mencapai standar yang lebih tinggi.
Dalam penentuan tingkat konsumsi, seorang konsumen harus
mempertimbangkan intertemporal budget constraint 
ukuran yang menunjukkan total sumberdaya yang tersedia
untuk konsumsi pada saat ini dan pada masa mendatang.
 The basic two-period model
Period 1: the present
Period 2: the future
Notation

Y1, Y2 = income in period 1, 2

C1, C2 = consumption in period 1, 2
S = Y1  C1 = saving in period 1
(S < 0 if the consumer borrows in period 1)

Note: there is no saving in period 2. Period 2 is the final period, so saving

in period 2 would only reduce lifetime consumption and therefore lifetime
utility/satisfaction.
 Deriving the intertemporal budget constraint

Period 2 budget constraint:

C 2  Y 2  (1  r ) S
 Y 2  (1  r ) (Y1  C 1 )

 Rearrange terms:
(1  r ) C 1  C 2  Y 2  (1  r )Y 1

 Divide through by (1+r ) to get…

Note: r is return from saving

The intertemporal budget constraint

C2 Y2
C1   Y1 
1r 1r

present value of present value of

lifetime consumption lifetime income
 The intertemporal budget constraint
C2

Consump =
Saving income in
The
The budget
budget both periods
constraint
constraint shows
shows allall
combinations
combinations Y2
of
of C
C11 and
and C
C22 that
that Borrowing
just
just exhaust
exhaust the
the
consumer’s
consumer’s C1
resources.
resources. Y1
The intertemporal budget constraint

C2

The
The slope
slope of
of
the
the budget
budget line
line
equals
equals 1
(1+r
(1+r )) (1+r )

Y2

C1
Y1
 Consumer preferences
Higher
Higher
C2
An indifference indifference
indifference
curve shows curves
curves
all combinations of represent
represent
C1 and C2 higher
higher levels
levels
that make the of
of happiness.
happiness.
consumer
equally happy. IC2

IC1
C1
 Consumer preferences
C2 The
The slope
slope of
of
Marginal rate of an
an indifference
indifference
substitution (MRS ): curve
curve atat any
any
the amount of C2 point
point equals
equals
the consumer the
the MRS
MRS
would be willing to 1 at
at that
that point.
point.
substitute for MRS
one unit of C1.
IC1
C1
 Optimization
C2
The optimal (C1,C2) is
At
At the
the optimal
optimal point,
point,
where the
MRS
MRS == 1+r
1+r
budget line
just touches
the highest
indifference curve. O

C1
 How C responds to changes in Y
C2 An
An increase
increase
Results:
in
in YY11 or
or YY22
Provided they are
shifts
shifts the
the
both normal goods, budget
budget lineline
C1 and C2 both outward.
outward.
increase,
…regardless of
whether the
income increase
occurs in period 1
or period 2. C1
Absolute Income Hypothesis vs. Relative Income Hypothesis

Absolute Income Hypothesis :

Current consumption depends only on
current income.
Relative Income Hypothesis :
Current consumption depends only on
the present value of lifetime income.
The timing of income is irrelevant because the
consumer can borrow or lend between periods.
How C responds to changes in r
An
An increase
increase in in rr
pivots
pivots the
the budget
budget
line
line around
around the
the
point
point (Y
(Y11,Y
,Y22).).

As depicted here,
C1 falls and C2 rises.
However, it could turn
out differently…
 How C responds to changes in r

income effect: If consumer is a saver,

the rise in r makes him better off, which tends to
increase consumption in both periods.
substitution effect: The rise in r increases
the opportunity cost of current consumption,
which tends to reduce C1 and increase C2.
Both effects C2.
Whether C1 rises or falls depends on the relative size of
the income & substitution effects.
Bagaimana pengaruh Zakat & sedekah dalam hipotesis
ini?
Redistribusi pendapatan (melalui Zakat & sedekah) tidak
meningkatkan konsumsi agregat:
Pengurangan pendapatan pada kelompok kaya akan
menurunkan tekanan pada kelompok miskin (yang
menghendaki standar hidup yang sama).
Penerima Zakat & sedekah akan mengeluarkan semua
pendapatan hanya cukup untuk memenuhi kebutuhan dasar.
Pembayar zakat & sedekah akan menabung sebagian
pendapatan (untuk masa depan) guna mengimbangi
pengeluarannya pada saat ini.
Zakat & sedekah akan mengurangi tingkat konsumsi dan
mengurangi ketidak merataan  dapat meningkatkan
jumlah tabungan  menaikkan investasi
3. The Permanent Income Hypothesis
 Milton Friedman (1957)
Menurut hipotesa ini, perilaku konsumsi mengarah
pada konsumsi permanen jangka panjang.
Y = Y P + Y T
where
Y = current income
Y P = permanent income
pendapatan rata-rata, yang diharapkan tetap diperoleh
sampai masa depan (dalam jangka waktu lama)
Y T = transitory income (Pendapatan tidak permanen)
deviasi sementara dari pendapatan rata-rata (bisa
menambah atau mengurangi)
 The Permanent Income Hypothesis
Consumers use saving & borrowing to
smooth consumption in response to
transitory changes in income.
The PIH consumption function:
C = Y P
where  is the fraction of permanent
income that people consume per year.

Smooth consumption: menyeimbangkan pengeluaran & pendapatan

agar mencapai standar hidup yang tertinggi.
 The Permanent Income Hypothesis

The PIH can solve the consumption puzzle:

The PIH implies
APC = C / Y = Y P/ Y
If high-income households have higher transitory
income than low-income households, APC is lower
in high-income households.
Over the long run, income variation is due mainly (if
not solely) to variation in permanent income, which
implies a stable APC.
Bagaimana pengaruh Zakat & sedekah dalam
hipotesis ini?
Redistribusi pendapatan melalui zakat &
shadaqah akan:
Menguntungkan kelompok miskin & yang
memerlukan
Tidak mempengaruhi konsumsi agregat
(selama zakat & sedekah hanya
mempengaruhi pendapatan permanen, bukan
pendapatan transitory)
4. The Life-Cycle Hypothesis
 Franco Modigliani (1950s)
Hipotesi Pendapatan Relatif: konsumsi tergantung pada
pendapatan seumur hidup (lifetime income), dan seseorang
berupaya mencapai smooth consumption.
Hipotesa siklus hidup: pendapatan bervariasi secara
sistematis selama “siklus hidup” seseorang dan dengan
menabung akan memungkinkan orang tersebut mencapai
smooth consumption.
 Jadi dalam hipotesa siklus hidup, konsumsi tidak hanya
tergantung pada pendapatan saat ini, tapi juga pada
kekayaan & pendapatan yang diharapkan pada masa
mendatang.
 The Life-Cycle Hypothesis
The basic model:
W = initial wealth
Y = annual income until retirement (assumed
constant)
R = number of years until retirement
T = lifetime in years
Assumptions:
Tidak ada suku bunga
consumption-smoothing adalah optimal
 The Life-Cycle Hypothesis
Lifetime resources = W + RY
To achieve smooth consumption,
consumer divides her resources equally over time:
C = (W + RY )/T , or
C = W + Y
where
 = (1/T ) is the marginal propensity to consume out of wealth
 = (R/T ) is the marginal propensity to consume out of income
 Implications of the Life-Cycle Hypothesis

The LCH can solve the consumption puzzle:

The life-cycle consumption function implies
APC = C/Y = (W/Y ) + 
Across households, income varies more than wealth,
so high-income households should have a lower
APC than low-income households.
Over time, aggregate wealth and income grow
together, causing APC to remain stable.
 Implications of the Life-Cycle Hypothesis
$

The
The LCH
LCH
Wealth
implies
implies that
that
saving
saving varies
varies
systematically
systematically
Income
over
over aa person’s
person’s
lifetime.
lifetime. Saving

Consumption Dissaving

Retirement End
begins of life
 PIH vs. LCH
Both: people try to smooth their consumption in the
face of changing current income.
PIH: current income is subject to random, transitory
fluctuations.
LCH: current income changes systematically as
people move through their life cycle.
Both can explain the consumption puzzle.
Bagaimana pengaruh Zakat & sedekah dalam
LCH?
Sama halnya dengan PIH, redistribusi
pendapatan melalui zakat & shadaqah akan:
Menguntungkan kelompok miskin & yang
memerlukan
Tidak mempengaruhi konsumsi agregat
Bibliography
Hasan, Zubair, 2005, ‘Treatment of Consumption
in Islamic Economics: An Appraisal’, Journal KAU:
Islamic Economics., Vol. 18, No. 2, pp. 29-46.
Khan, Fahim, 1995, Essays in Islamic Economics,
The Islamic Foundation.
Mankiw, N.G., 2007, Macroeconomics, 6ed.,
Worth Pub.
Metwally, M.M., 1995, Teori dan Model Ekonomi
Islam, Edisi Terjemah oleh Husain Sawit, Bangkit
Daya Insana.