Consumption Function

12 Key excerpts on "Consumption Function"

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  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Let’s look at this link in the U.S. economy over time. 9-1a Consumption and Income Exhibit 1 shows the relationship between consumption and income in the United States since 1959; disposable income is measured along the horizontal axis and consump- tion along the vertical axis. Notice that each axis measures the same units: trillions of Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 9 Aggregate Demand 189 2009 dollars. Each year is depicted by a point that reflects two flow variables: dispos- able income and consumption. For example, the combination for 2000, identified by the red point, shows that when disposable income (measured along the horizontal axis) was $8.9 trillion, consumption (measured along the vertical axis) was $8.2 trillion. As you can see, there is a clear and direct relationship between consumption and disposable income. You need little imagination to figure out that by connecting the dots, you could trace a line relating consumption to income. This relationship has spe- cial significance in macroeconomics. 9-1b The Consumption Function After examining the link between consumption and income, we found it to be quite stable. Based on their disposable income, households decide how much to consume and how much to save. Scarcity prevents you from both spending and saving the same dol- lar. So consumption depends on disposable income. Consumption is the dependent vari- able and disposable income is the independent variable. Because consumption depends on income, we say that consumption is a function of income.

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  The Economic Organization of the Household

  • W. Keith Bryant, Cathleen D. Zick(Authors)
  • 2005(Publication Date)
  • Cambridge University Press

    (Publisher)

  Such policies and the relationships underlying them are discussed in macroeconomics courses. Suffice it to say here that crucial to the effective-ness of such policies is the relationship between income and consumption, or the so-called Consumption Function. The simple framework that has just been introduced is well suited for a discussion of the Consumption Function. The relation between income and consumption is the familiar Engel curve that was introduced and discussed in Chapter 3 . There, the Engel curve was used to examine the relation Consumption and Saving 101 between income and the demand for particular goods such as food, toys, or electricity. Here in Chapter 4 , we use it to examine the relationship between consumption and income, where consumption is expenditures on all the goods the household buys. We begin the discussion of the income-consumption relation with the absolute income hypothesis. Discussions of the permanent income and the life-cycle income hypotheses follow. The discussion ends with some of the modifications to the permanent income hypothesis that have been stimulated by events in the past twenty-five years. The history of these several hypotheses is included, in part, to show the student the interplay between theoretical and empirical research. the absolute income hypothesis The first conception of the Consumption Function was the absolute income Consumption Function introduced by John Maynard Keynes in 1936 . Keynes did not begin with the framework we have laid out in this chap-ter. Instead, he postulated that the “fundamental psychological law . . . is that men are disposed as a rule and on the average to increase their con-sumption as their income increases but not by as much as the increase in their income” ( 1936 , p. 96).

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  Modern Economic Thought

  • Sidney Weintraub(Author)
  • 2016(Publication Date)
  • University of Pennsylvania Press Anniversary Collection

    (Publisher)

  4 Keynesian Econometric Concepts: Consumption Functions, Investment Functions, and The Multiplier RONALD G. BODKIN* Consumption The modern theory of aggregate Consumption Functions begins with the monumental work of John Maynard Keynes. Keynes postulated, as a fundamental building-block of his system, a functional relationship between aggregate consumption and aggregate income, both deflated in terms of wage units. 1 In a survey, only several salient points can be discussed. First, it is interesting to note that the deflator selected by Keynes was the money wage rate. Later students and developers of the Keynesian system have, with rare exceptions (such as Sidney *I wish to thank Eric Davis, A. Asimakopulos, and Sidney Weintraub for their com-ments on this paper. I confess that I have shamelessly consulted four other surveys of Consumption Functions, those by Robert Ferber, Thomas Mayer, Irwin A. Shapiro, and James Tobin. As I have consulted unpublished versions of the latter two surveys, my debts are compounded. 'John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt, Brace & Co., 1936). 67 6 8 RONALD C. BODKIN Weintraub 2 ) modified this deflator to be the aggregate price level. 3 Second, the only principle concerning the shape of this function on which Keynes was willing to commit himself strongly was that the marginal propensity to consume (the slope of this function) had to lie between zero and unity. He thought it quite likely that the average propensity to consume declined with rising community income and he perhaps believed as well that the marginal propensity to consume also declined with rising income. 4 But only the basic assertion was elevated to the status of a fundamental psychological law. Third, it is worth noting that Keynes' discussion was quite intricate, with a number of the qualifications, at least in embryonic form, which we often associate with later writers.

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  Applied Intermediate Macroeconomics

  • Kevin D. Hoover(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  488 An Introduction to Aggregate Demand total. In later chapters, we examine each of the different elements in more detail. 13.1.1 Consumption Behavior Consumption is the largest component of aggregate expenditure (see Fig-ure 2.6 and Problem 2.1). We can make a start at understanding aggregate demand by understanding consumption. The Consumption Function Many factors determine how much people consume. (We consider consump-tion in detail in Chapter 14.) One factor stands out above all the others: typi-cally, people consume more if they have more income. In his General Theory of Employment, Interest and Money (1936), John Maynard Keynes famously put it this way: 1 The fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption, as their income increases, but not by as much as the increase in their income. (p. 96) This means that if you receive an additional dollar of income, you will increase your expenditure, but by less than one dollar. The amount that you increase your expenditure is known as the MARGINAL PROPENSITY TO CONSUME (or mpc ) and is defined as the rate at which consumption increases when (disposable) income is increased by a small increment . The mathematical relationship between consumption and the factors that determine it is known as the Consumption Function . A simple linear con-sumption function captures Keynes’s point: C = c 0 + cYD . (13.2) C is, of course, consumption; YD is disposable income; and c 0 and c are parameters that must be determined from data. Figure 13.1 portrays the function. Its slope is the marginal propensity to consume: C / Y = c (or, using derivatives, d C / d Y = c ). Keynes’s fundamental psychological law can be restated: 0 < c < 1 – the marginal propensity to consume lies between zero and one.

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  Macroeconomics

  • William Boyes, Michael Melvin(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. because every point on the line represents the same value on both axes.) This line splits the area of the figure in half and shows all points at which the value of disposable income and the value of consumption are equal. Since the actual Consumption Function lies below the 45-degree line, it can be seen that consumption is less than disposable income—but not much less. The Consumption Function in Figure 2 is a long-run Consumption Function. In the short run, like this year, the relationship between consumption and disposable income may be much flatter than that shown in Figure 2. We now turn to a deeper analysis of the Consumption Function to better understand this important relationship. To focus on the relationship between income and consumption, we draw a new graph, Figure 3, with income on the horizontal axis and consumption on the vertical axis. Figure 3(a) shows a hypothetical Consumption Function. In this economy, when disposable income is zero, consumption is $30. As disposable income rises, consumption rises. For instance, when disposable income is $100, consumption is $100. We use C to represent consumption and Yd to represent disposable income. The line labeled C in Figure 3a is the Consumption Function: It represents the relationship between disposable income and consumption. The other line in the figure creates a 45-degree angle with either axis. In Figure 3a, as in Figure 2, the 45-degree line shows all the points where consumption equals disposable income. The level of disposable income at which all disposable income is being spent occurs at the point where the Consumption Function (line C ) crosses the 45-degree line. In the graph, C equals Yd when disposable income is $100.

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  Understanding Keynes' General Theory

  • B. Sheehan(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  5 Consumption and Effective Demand a) Introduction This chapter will explain how the Consumption Function underpins the derivation of aggregate effective demand in the General Theory model. The purpose is to make clear the connections between the materials in Chapters 3 and 4. Keynes alludes to these linkages in the General Theory but does not amplify them. The chapter will demonstrate that, given the level of aggregate investment spending, the value of the propensity to consume determines effective demand; it highlights the way in which changes in the propensity to consume influences the level of effective demand, and hence the volumes of employment, income and saving. The forces that determine investment spending and cause it to fluctuate are discussed in the forthcoming Chapters 6, 7 and 8. Section (b) examines the ways real Consumption Function helps to specify the real aggregate demand function, and how changes in the propensity to consume influence the real aggregate demand price. Section (c) examines the relationship between the real Consumption Function and the levels of real aggregate effective demand. Section (d) outlines Keynes’ famous concept of the Paradox of Thrift. Finally, Section (e) provides a causal map of the General Theory model to date. An appendix to this chapter considers the under-consumptionist theories of deficient demand, which can be seen as a special case of the General Theory model. b) Consumption and the aggregate demand function It is important to explain how the real Consumption Function [i.e. C w = χ (Y w ) or C w = χ (N)] derived in Chapter 4 can be used to derive a real aggregate demand function [i.e. D w = F w (N)] defined in Chapter 3. 92

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  Microeconomics

  Equilibrium and Efficiency

  • Thijs ten Raa(Author)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  39 II The Demand Side of the Economy In this part of the book we develop a rather formal yet practical approach to economic modeling. First we define an economy, its main operations – production and consumption – and the closely related concepts of supply and demand. Not surprisingly, the first building block of our economic modeling is the consumer theory. After all, the objective of an economic system is to meet consumer needs. Production is merely a means to achieve this end. Part II consists of three chapters. Chapter 3 models consumer preferences by means of utility functions. A utility function is a tool for comparing alterna-tive bundles of goods and services; it reveals which one is preferred. In applied economic models, utility functions are of the constant elasticity of substitution variety, a tool that will be explained in detail. Chapter 4 analyzes the implications for the demand side of the economy, how consumers respond to price and income changes. Chapter 5 attempts to measure the standard of living, shows how this can be done and outlines the potential pitfalls. 41 3 Utility and expenditures 3.1 Introduction An economy is a machine operated by producers who transform resources into goods and services that can be used by consumers. The transformation into goods and services is called production and the use is called consumption . In market economies both producers and consumers respond to prices. Producers shift their resources to the production of goods and services that carry a good price. In other words, the quantities produced are functions of the prices; these func-tions are the supply functions. Supply functions summarize what producers do under the assumption of profit maximization. Consumers allocate their budgets to goods and services that carry a good price, but now it means a low price. The quantities consumed are also functions of the prices, namely demand functions.

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  The Failure of the "New Economics": An Analysis of the Keynesian Fallacies

  • Henry Hazlitt(Author)
  • 2016(Publication Date)
  • Golden Springs Publishing

    (Publisher)

  General Theory (pp. 89-90).

  But if we go back to Keynes’s own equation that income = consumption + investment, or if we turn merely to common sense, we might conclude that every dollar of income spent on consumption goods must leave a dollar less to be spent on investment goods, while every dollar spent on investment must leave a dollar less to be spent on immediate consumption. How the factors governing two quantities related to each other as subtrahend and remainder could be “largely distinct” is puzzling. But we shall postpone consideration of this paradox to a later stage.

  We come at last to the famous Keynesian concept of “the propensity to consume”: “We will therefore define what we shall call the propensity to consume as the functional relationship between Yw , a given level of income in terms of wage-units, and Cw the expenditure on consumption out of that level of income” (p. 90).

  Keynes creates several difficulties here, as usual. He is trying to define the relationship of consumption to income in real rather than in monetary terms, and therefore he talks in terms of “wage-units.” But we have seen (p. 64) that Keynes so defines the wage-unit as to make it in fact a concept that can only be conceived in monetary terms, since “wage-units” are added together exactly in proportion to monetary wages , because “an hour of special labor remunerated at double ordinary rates will count as two units” (p. 41). We must forget “wage-units,” therefore, in order to substitute what Keynes thought he was comparing, which is real consumption with real income.

  Another difficulty to be dealt with is the misleading nature of the term itself—“propensity to consume.” Keynes’s definition shows that he is not in fact dealing with a “propensity” in the dictionary sense—a “natural or habitual inclination or tendency”; he is dealing with a mathematical relationship . He is dealing with the fraction or percentage of its income that the community in fact spends on consumption goods at different levels of income, regardless of what its propensities or inclinations may be. If the community spends 90 per cent, or nine-tenths, of its income on “consumption,” then its “propensity to consume” is nine-tenths, or 9/ 10.

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  The Singapore Economy

  An Econometric Perspective

  • Tilak Abeysinghe, Keen Meng Choy(Authors)
  • 2007(Publication Date)
  • Taylor & Francis

    (Publisher)

  2 The aggregate Consumption Function

  2.1 Introduction

  The aggregate Consumption Function is perhaps the most basic building block of a macroeconometric model.1 It is also the logical starting point of Keynes’ theory of effective demand, which manifests itself in households spending their income on consumption of goods and services. Together with gross investment expenditures, private consumption spending contributes to domestic demand in Singapore and an understanding of the factors that affect it is essential for both analytical and prediction purposes.

  Empirical Consumption Functions estimated for most countries have traditionally employed a log-linear functional specification with measures of income and wealth as basic explanatory variables. In simple Consumption Functions without a wealth variable, a constant long-run average propensity to consume (APC) requires the income elasticity of consumption expenditures to be unity. However, the handful of researchers who have estimated such Consumption Functions for Singapore in the context of macroeconometric models obtained elasticities that are well below one, thus implicitly allowing the APC to fall as income increases2 (Wong, 1974; Lim and Associates, 1988, Chapter 16; Toh and Ramstetter, 1994). We have dubbed this curious phenomenon of a falling APC the “aggregate consumption puzzle” in Singapore (Abeysinghe and Choy, 2004). Our aim in this chapter is to resolve the puzzle and at the same time, present the equilibrium and short-run Consumption Functions that are built into the ESU01 model.

  2.2 The consumption puzzle

  A rough way to calculate the APC is to take the ratio of real private consumption expenditures to real GDP. In Singapore, this ratio has fallen steadily over time from 0.80 in 1960 to 0.42 in 2003 (Figure 2.1 ), producing the lowest share of

  Figure 2.1 The APC in Singapore.

  private consumption in output in the free world. Even amongst the former centrally planned economies, Ermisch and Huff (1999) noted that the lowest share of private consumption reached in the Soviet Union was 55%.

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  Managerial Economics for Decision Making

  • John Adams, Linda Juleff(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  The 45° line should have given you the clue that b is a proportion which is less than 100 per cent, that is, the slope of the Consumption Function drawn from a is less than 1. This means that if income rises by 1 consumption rises by less than 1. So, we can interpret b as representing the proportionate addition to consumption arising out of increased income. The symbol b, and what it represents, is more commonly referred to as the marginal propensity to consume (or MPC) out of extra income. The word ‘marginal’ is used to refer to the fact that we are talking about increases or decreases in consumption which occur even with small increases or decreases in income. Suppose the MPC is 80 per cent then this means that an increase in income of £1 will lead to a rise in consumption of 80 pence and an increase in income of £50 will lead to a rise in consumption of £40, that is (40/50)*100 = 80 per cent. The opposite is also generally true: if income falls by £40 then consump-tion will fall by £32. But what about the other 20 per cent of an increased or reduced income? If it is not being spent on domestic or imported goods and services then it must be getting saved and therefore invested. You now should have a good under-standing of the nature of consumption, that is, what controls it, and be able to use the Consumption Function to determine whether spending will rise and by how much given a change in income. We will now turn to another component of our aggregate demand equation – investment – and consider how it is related to both savings levels and the rate of interest. We have already explained that investment levels depend on the prevailing rate of interest and that investment always equals savings. This is because at the prevailing rate of interest (that is, the price of/return from borrowing/lending money), people will plan to save a given amount and firms will plan to invest a given amount.

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  Theory of the Consumption Function

  • Milton Friedman(Author)
  • 2018(Publication Date)
  • Princeton University Press

    (Publisher)

  The term is generally used in statistical studies to designate actual expenditures on goods and services. It therefore differs from the value of services it is planned to consume on two counts: first, because of additions to or subtractions from the stock of consumer goods, second, because of divergencies between plans and their realization. Let us use the terms "permanent income" and "permanent consumption" to refer to the concepts relevant to the theoretical analysis, so as to avoid confusion with the frequent usage of income as synonymous with current receipts and consumption as synonymous with current expenditures, and let us designate them by y p and c P respectively, with an additional numerical subscript to denote the year in question. 6 We can write the Consumption Function as (2.4) C r t - f ^ since y pl = iW v This approach seems somewhat forced for the present simple case of a horizon of only two years. Initial wealth is then spent on con- sumption during the two years, rather than being maintained. It makes much more sense if (2.4) is regarded as a generalization from this special case to a longer horizon. 7 The only empirical restrictions that have been imposed on the indifference curves up to this point are that they be negatively sloped (to be consistent with the observed absence of a tendency for individuals to give their wealth away indiscriminately) and convex to the origin (to be consistent with the observed absence of a tendency for individuals to spend their entire wealth on 6 The adjective "planned" would perhaps be more appropriate in the present context than "permanent." The reason for using the latter will appear in Chap. I l l below. 7 The transformation used to convert (2.2) into (2,4) raises difficulties for / = 0.

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  A Short Course in Intermediate Microeconomics with Calculus

  • Roberto Serrano, Allan M. Feldman(Authors)
  • 2018(Publication Date)
  • Cambridge University Press

    (Publisher)

  We will start this chapter with a detailed study of individual demand functions. Each demand function depends on three independent variables. Because of this com-plication, it would be impossible to graph them in the obvious way. (We would need four dimensions!) Therefore, we will look at how demand changes as we vary one independent variable at a time. This exercise is called comparative statics because we are comparing the consumer’s optimal consumption of goods 1 and 2, as one of the exogenous variables – one of the prices, or income – changes from one level to another. From now on, we shall concentrate on the demand function for just one of the goods, say, good 1. In Section 4.2 , we will focus on demand as a function of income, holding prices constant. We will derive an Engel curve, a graph which shows the desired consumption of a good as a function of income. We will distinguish between normal goods (higher income results in higher consumption) and inferior goods (higher income results in lower consumption). In Section 4.3 , we will focus on demand as a function of price, and we will discuss the consumer’s standard demand curve (showing quantity as a function of price), as well as her inverse demand curve (showing price as function of quantity). In Section 4.4 , we will analyze the demand for good 1 as a function of the price of good 2, and in Section 4.5 , we will consider income and substitution effects. An income effect is a change in consumption attributable to a change in income, and a substitution effect is a change in consumption attributable to a change in relative prices. There are actually several ways to measure the substitution effect, and we 48 4 Demand Functions discuss and graph three alternative methods.

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