Economics: Consumption Function and MPC

Consumption Function

• The function that shows the relationship between consumption and income
• Represented by equation: C = C + bY
  • Where: C = Autonomous consumption
  • C = Consumption expenditure
  • Y = National income
  • b = Marginal Propensity to Consume (MPC)
• MPC is the change in consumption due to a change in income, represented by the slope of the consumption function
• In the text example, the consumption function is C = 100 + 0.75Y
  • C = 100 crore (autonomous consumption)
  • b = 0.75 (MPC)
  • Meaning: For every ₹1 increase in income, consumption expenditure rises by ₹0.75
• The consumption function shows that consumption is dependent on income, but also includes a portion of consumption that occurs even when income is zero (autonomous consumption)

Marginal Propensity to Consume (MPC)

• MPC is the ratio of change in consumption expenditure to change in income
• MPC = ΔC/ΔY
• Takes values between 0 and 1, meaning that consumption can never increase by more than the increase in income
• An MPC of 0.6 means that for every ₹1 increase in income, consumption expenditure increases by ₹0.6

Average Propensity to Consume (APC)

• APC is the ratio of total consumption expenditure to total income
• APC = C/Y
• Values between 0 and 1, meaning that consumption cannot exceed income
• As income increases, APC generally decreases

Savings Function

• Shows the relationship between savings and income
• S = Y - C, where:
  • S = Savings
  • Y = Income
  • C = Consumption expenditure
• Derivable from the consumption function
• Represented by equation: S = -C + sY
  • Where: -C = Dissavings at zero income
  • s = Marginal Propensity to Save (MPS)
  • Y = National income

Marginal Propensity to Save (MPS)

• MPS is the ratio of change in savings to change in income
• MPS = ΔS/ΔY
• Takes values between 0 and 1.
• Represents the proportion of each additional rupee of income that is saved
• MPS and MPC are complements and their sum is always equal to 1 (MPS + MPC = 1)

Average Propensity to Save (APS)

• APS is the ratio of total savings to total income
• APS = S/Y
• Values between 0 and 1
• As income increases, APS generally increases

Relationship between Consumption and Savings

• Complementary curves
• Consumption curve can be derived from savings curve and vice-versa
• As income increases, APC decreases, and APS increases which means people tend to consume a smaller proportion of their income and save a larger proportion.