Consumption

and
Saving
Consumption

 Can be defined as, expenditures Consumption is divided into three

by households on final goods and categories:
services.  Durable goods
 It is the largest single component  Non-durable goods
of Gross Domestic Product (GDP),
 Services
constituting 66% of total spending
over the last decade.
3 Categories of Consumption

 Durable goods
are a category of consumer products that do not need to be purchased frequently because
they are made to last for a long time (usually lasting for three years or more). They are also
called consumer durables or durables.
 Non-durable goods
A good which is immediately used by a consumer or which has an expected lifespan of three
years or less. Examples of non-durable goods include food and clothing.

 Service
A type of economic activity that is intangible, is not stored and does not result in ownership. A
service is consumed at the point of sale. Services are one of the two key components
of economics, the other being goods.
 Budgetary Expenditure Patterns

Engel's Law
An economic theory introduced in 1857 by Ernst
Engel, a German statistician, stating that the
percentage of income allocated for food purchases
decreases as income rises. As a household's income
increases, the percentage of income spent on food
decreases while the proportion spent on other
goods (such as luxury goods) increases.

For example, a family that spends 25% of their

income on food at an income level of $50,000 will
spend $12,500 on food. If their income increases to
$100,000, it is not likely that they will spend $25,000
(25%) on food, but will spend a lesser percentage
while increasing spending in other areas.
Budgetary Expenditure Patterns
Budgetary Expenditure Patterns

 Adding together individual consumption

functions gives us the NATIONAL
CONSUMPTION FUNCTION. In simplest
form, it shows total consumption
expenditures as a function of disposable
income.
Saving

 Is properly defined as, “the part of personal

disposable income that is not consumed.”

SAVING = INCOME – CONSUMPTION

 Saving

Item Amount
($, billion)
Personal Income 8,929
Less: Personal Taxes (1,114)
Equals: Disposable Personal Income 7,816
Less: Personal outlays (consumption & interest) (7,525)
Equals: Personal Saving 291
Memo: Personal saving as percent of disposable personal 291/7816 = 3.72 %
income
Break-even point (Y=C)

Disposable income Net Saving (+) or Consumption

($) Dissaving (-) ($)
($)

A 24,000 -200 24,200

B 25,000 0 25,000
C 26,000 200 25,800

D 27,000 400 26,600

E 28,000 600 27,400

F 29,000 800 28,200

G 30,000 1,000 29,000

Reasons for the Decline in the Personal Saving Rate

 Social security system

 Capital markets

 Rapid growth in wealth

ALTERNATIVE MEASURE OF SAVING

 Saving as measured in national income and product accounts is

not the same as that measured by accountants or in balance
sheets.
 The NATIONAL–ACCOUNTS MEASURE OF SAVING is the difference
between disposable income (excluding capital gains) and
consumption.
 The BALANCE SHEET MEASURE OF SAVING calculates the change in
real net worth (that is, assets less liabilities, corrected for inflation)
from one year to the next; this measure includes real capital gains.
DETERMINANTS OF CONSUMPTION & SAVING

 Current Disposable Income

 Permanent Income (permanent-income hypothesis – Milton Friedman)
and the Life-Cycle Model of Consumption (Franco Modigliani)
 Wealth & Other Influences
 Wealth effect
 Expectations
 Household Debt
 Taxes and Transfers
Reminders:

 High consumption relative to income spells low

investment and slow growth.
 High saving leads to high investment and rapid growth.
 When economic conditions give rise to rapidly growing
consumption and investment, this increases total
spending or aggregate demand, raising output and
employment in the short run.
CONSUMPTION and
SAVING FUNCTION
Disposable income (DI)

 Defined as “what consumers have left over to spend or save once

they have paid out their net taxes.”

DI = Gross Income – Net Taxes

*where net taxes = (taxes paid – transfers received)

With no government transfers or taxation, DI = C + S.

DI = C + S or Y=C+S

DISPOSABLE INCOME CONSUMPTION (C) SAVING (S)

(DI)
0 40 -40
100 120 -20
200 200 0
300 280 20
400 360 40
500 440 60
CONSUMPTION FUNCTION

 It shows the relationship between the level of the level

of consumption expenditures and the level of
disposable personal income. This concept, introduced
by Keynes, is based on the hypothesis that there is a
stable empirical relationship between consumption
and income.

C = a + bY
C = 40 + .80(Y)
CONSUMPTION FUNCTION

Disposable income Net Saving (+) or Consumption

($) Dissaving (-) ($)
($)

A 24,000 -200 24,200

B 25,000 0 25,000
C 26,000 200 25,800

D 27,000 400 26,600

E 28,000 600 27,400

F 29,000 800 28,200

G 30,000 1,000 29,000

CONSUMPTION FUNCTION
SAVING FUNCTION

shows the relationship between

the level of saving and income.
SAVING FUNCTION

Disposable income Net Saving (+) or Consumption

($) Dissaving (-) ($)
($)

A 24,000 -200 24,200

B 25,000 0 25,000
C 26,000 200 25,800

D 27,000 400 26,600

E 28,000 600 27,400

F 29,000 800 28,200

G 30,000 1,000 29,000

SAVING FUNCTION
MARGINAL PROPENSITY TO CONSUME (MPC)

 It is the additional or extra consumption that results from an extra dollar of

disposable income. Graphically, it is given by the slope of the
consumption function.

MPC = C/ DI = CONSTANT SLOPE OF CONSUMPTION FUNCTION

Helpful terms:
 Marginal – extra or additional
 Propensity to consume – desired level of consumption
MARGINAL PROPENSITY TO CONSUME (MPC)
MARGINAL PROPENSITY TO SAVE (MPS)

 It is the extra saving generated by an extra dollar of disposable income.

Graphically, this is the slope of the saving schedule

MPS = S/ DI = CONSTANT SLOPE OF SAVING FUNCTION

MPC and MPS

1 2 3 4 5
Disposable Consumption Marginal Propensity Net Saving ($) Marginal Propensity to
Income (after Expenditure ($) to Consume (MPC) 4=1-2 Save (MPS)
taxes)
($)

A 24,000 24,200 -200

800/1,000=0.80 200/1000=0.20
B 25,000 25,000 0
800/1,000=0.80 200/1000=0.20
C 26,000 25,800 200
800/1,000=0.80 200/1000=0.20
D 27,000 26,600 400
800/1,000=0.80 200/1000=0.20
E 28,000 27,400 600
800/1,000=0.80 200/1000=0.20
F 29,000 28,200 800
800/1,000=0.80 200/1000=0.20
G 30,000 29,000 1,000
MPC and MPS

 MPS + MPC = 1

 MPS = 1 – MPC

 MPC = 1 – MPS
 Equilibrium Aggregate Output

Equilibrium – there is no tendency for change

Aggregate Output – total quantity of goods and services produced (or supplied) in an economy in
a given period
Aggregate Income – total income received by all factors of production in a given period
Aggregate Output (Income) (Y) – combined term used to remind the exact equality between
aggregate output and aggregate income
Equilibrium Aggregate Output

Aggregate Expenditure – total amount the economy plans to spend in a given period.
AE = C + I
The economy is defined to be in equilibrium when aggregate output (Y) is equal to planned
aggregate expenditure (AE).
Equilibrium: Y = AE
Because AE is, by definition, C + I, equilibrium can also be written:
Equilibrium: Y = C + I
Assumptions:
Y > AE AE > Y
 Equilibrium Aggregate Output

Aggregate Aggregate Planned Planned Unplanned Equilibrium

Output Consumption Investment (I) Aggregate Inventory (Y=AE)
(Income) (Y) (C) Expenditure Change
(AE) C+I Y-(C+I)

100 175 25 200 -100 No

200 250 25 275 -75 No
400 400 25 425 -25 No
500 475 25 500 0 Yes
600 550 25 575 25 No
800 700 25 725 75 No
1,000 850 25 875 125 No
Equilibrium Aggregate Output
Equilibrium Aggregate Output

Aggregate Income (Y) Aggregate Consumption (C)

0 100

80 160

100 175

200 250

400 400

500 475

600 550
Equilibrium Aggregate Output

Y=C+I
C = 100 + .75Y
I = 25
Substitution: Y = 100 + .75Y + 25
Y - .75Y = 100 + 25
Y- .75Y = 125
.25Y = 125
Y = 125 / .25 = 500
Investment
INVESTMENT

 It plays two roles in macroeconomics:

 Affecting
short-run output through its impact on
aggregate demand
 Influencinglong-run output growth through the
impact of capital formation on potential output and
aggregate supply.
DETERMINANTS OF INVESTMENT

 Revenues

 Costs

 Expectations
Investment
Demand
Curve
a schedule showing
the relationship
between interest rates
and investment
Shifts in the
Investment
Demand
Curve
An important relationship is
the investment demand
schedule, which connects
the level of investment
spending to the interest
rate. Because the
profitability of investment
varies inversely with the
interest rate, which affects
the cost of capital, we can
derive a downward-sloping
investment demand curve.
As the interest rate declines,
more investment projects
become profitable.
INVESTMENT MULTIPLIERS
Multiplier Effect

 It is the phenomena when a change in any component

of autonomous spending creates a larger change in
GDP
 Marginal Propensities to consume and save play a
critical role in determining the magnitude of the
multiplier
Multiplier Effect

FARMER Construction Worker

Spending Multiplier

 The magnitude of the Spending Multiplier is found by taking the ratio:

Using the Consumption Function= 40+.80(Y) earlier;

Multiplier is = 1/(1-MPC) = 1/(1-.80) = 5.
Since MPC + MPS = 1.
Multiplier = 1/MPS = 1/.20 = 5
Spending Multiplier

 Formulas:
 Multiplier = 1/MPS
 Multiplier = 1/(1-MPC)
 Multiplier = Change in GDP/Change in Spending
The Public and Foreign Sectors

 Government Spending (G) and Net Exports (X-M)

 Conveniently, these two are also influenced by the Multiplier effect. If a
certain increase or decrease in (G) or (X-M) occurs in the economy, it
could affect the GDP depending on the Multiplier.
Thank You! :3