# The consumption function describes relationship between household disposable income and

### Consumption Function: Concept, Characteristics and Possibility

function' in to describe the relationship between household's planned This relation implies that consumption depends on income or is a function of income. Every individual or household has its own consumption function. . Substituting a Rs. disposable income into the consumption equation, we have C. refer to both of them as aggregate income, and use the symbol Y to describe them We will focus on the relationship between aggregate income Y ( remember this of consumption expenditure on all goods by all households in the economy. So consumption and savings will be functions of disposable income, or (Y-T). Definition of consumption function C = a + b Yd where a=autonomous consumption, b = MPC and Yd = disposable income. Diagrams to explain.

You already have a sense of the answer, from our comparison of the effects of similar changes in G and T above. Because a change in G affects AD fully, while a change in T affects AD only in slightly diminished form by changing C first through the MPCchanging spending is just a little more powerful than changing taxes.

And in fact, you already know enough to tell exactly how much change in Y will be provoked by a matched change in G and T.

### The Relationship Between Income & Expenditure | posavski-obzor.info

And by doing that: And in fact, in this simple model the balanced budget multiplier is always exactly 1. If algebra makes you happy, you can get this result by adding up the two abstract formulas: When the economy is booming and inflationary pressures start to grow in the economy, the Government can decrease G and increase T.

If the budget is normally more or less in balance, then this means that the government runs deficits in recessions, and surpluses in booms. This should stabilize the level of aggregate expenditure and income in an economy.

When the government does this, it is called counter-cyclical policy.

Essentially the government is trying to damp down swings in Y. If these swings in Y are part of a normal "business cycle" in which periods of intense capital investment alternate with periods in which firms buy relatively few new capital goods, then it's especially easy to see the rationale for counter-cyclical G: If firms' intended investment Ip falls, that's a component of AD and Y will tend to fall.

In that case, in theory, G can be increased to make up for the fall in Ip. In real life, this is hard because it may take a while to actually figure out that Ip is dropping, and the political process of approving changes in G or T may drag on for long enough that by the time fiscal policy is actually changed, Ip has risen again.

### Consumption function - Wikipedia

In this case your intended counter-cyclical policy might actually end up being a pro-cyclical policy, amplifying rather than damping the changes in Ip. Counter-cyclical policy would also lower G when Ip rises, to reduce booms. You might wonder why anyone would want to do this - aren't booms good? The most often-heard arguments are a that a boom sets up conditions for a painful crash by encouraging over-investment too much Ip, so that it collapses once firms realize they have bought too many machines and b that overly-rapid growth provokes rapid inflation.

But in a more sophisticated model, transfer payments and taxes in particular will change as Y changes. If tax revenues are a percentage of income, then as Y rises taxes will rise by themselves.

If transfers like unemployment compensation rise when people lose their jobs and fall when employment rises, then when Y rises transfers fall, and when Y falls transfers rise. So since net taxes T represent total taxes minus transfer payments, it follows that T will rise when Y rises and fall when Y falls. Note that this amounts to a counter-cyclical policy as described in the previous section, but that it's automatic - it requires no extra decision by government to do this.

This kind of countercyclical policy is also pretty rapid. Another way of saying the same thing is that it sells securities IOUs. But suppose the government already owes money from previous deficits. Then this year's deficit adds to the total debt of the government. So the federal debt is the total amount owed by the federal government, while the deficit os the amount this debt rises in a single year.

In other words the debt is the cumulative total of all past deficits. Establishing Business Inventory Practices Another factor that affects consumer confidence in inventory.

## The Relationship Between Income & Expenditure

Supply and demand have a strong effect on whether buyers feel there is a need to purchase now. Going back to the house purchasing example, if there are not a lot of homes for sale but interest rates are low, supply is down but demand may increase.

This could lead to higher buying desires among consumers trying to get in while they can for the best deal possible. A business should consider its own inventory levels when seeing consumption schedules and consumer confidence ratings. When inventory increases for any item, it's less urgent to buy it.

When inventory builds up in a sector, such as in the automotive industry, it suggests reduced consumer confidence where conditions drive savings more than spending. A business in this sector would want to take heed and keep inventory levels manageable to prevent sitting on inventory stock for extended periods of time.

While no business can control consumer confidence, it can take proactive measures to protect itself as buyer trends change. A business may need to increase or reduce manufacturing, wholesale orders or it may even offer promotional pricing to retain profitability and movement in its inventory. Poor consumer confidence with a negative relationship between income and expenditures means less people are going to the movies, buying new cars, homes or spending less on the little extras they do when they feel that their pockets are a little deeper.

When income increases by Rs. This part of total consumption at higher level of income is called autonomous subsistence consumption. This is the minimum amount people must consume, irrespective of income, in order to survive. This is the break-even level of income and is shown by point d in Fig.

Consumption function

The third point to observe is that when national income is Rs. Point c in Fig. This is illustrated by point f in Fig. Point f shows that when national income is Rs. In other words, MPC falls.

## Consumption function definition

Both types of consumption function shown in Fig. Both the functions have positive intercepts. The positive slopes of both the curves imply that MPCs are positive at all levels of income.

The implication is the MPC is the same at all levels of income. However, APC continues to decline along the line C0 as income rises. The latter proposition may also be tested geometrically. In fact, the slope of the consumption function measures MPC.

In other words, the line C1 becomes flatter. Thus, successive increases in income cause less and less increases in consumption spending. We have noted that people spend a portion of their income and save the remaining portion of it.