Economics Chapter 8 PPT For Consumption

Chapter 8
The theory of Consumption, Saving and Investment

In this chapter, we discuss the relationship between income, consumption, saving and
investment
Income is the source of consumption expenditure, saving and investment
We also discuss about the relationship between saving and investment.
Consumption
Definition:- Consumption is an expenditure on final goods and service by households..
Consumption is one of the important concept under aggregate demand and aggregate
expenditure
Consumption is an amount of money households expend from disposable income for
satisfying their basic needs and wants .
Consumption is dependent on the amount of disposableincome.AS a matter of a fact there
are basic consumptions which are compulsory for survival even if our income is zero.
Consumption expenditure are made for clothing, food items, housing ,home furniture and
transportation.
There are two types of consumption based on their dependency on disposable income.:-
Autonomous consumption:-is a consumption expenditure made on items which are
compulsory for survival if our income is zero.
Induced consumption:- is a consumption expenditure which is dependent on our income
level. It is directly related with disposable income.
Yd =IC Yd =IC Where, Yd = disposable income ,IC = Induced consumption
Table 8.1 relationship betaken in come and consumption Expenditure
Yd Consumption (in money)

0 50
100 150
200 170
300 230
400 300
500 350
•Table 8.1 shows the direct relationship between disposable income and consumption. When disposable
income is zero, consumption is 50 indicate the presence of Autonomous consumption other figure below
zero explains the direct relationship between disposable income and consumption when disposable
income increased, consumption expenditure also increased.
•When we sum up the above individual household consumption we get the aggregate consumption
expenditure.
8.1.1 Determinants of consumption:-
There is a direct or positive relationship between disposable income and consumption
Yd =C where Yd = disposable income ,C = Induced consumption
1.Income distribution consumption expenditure among poor people per income is higher
than rich and wealthy people.
Unfair or income inequality influence consumption expenditure by reducing it’s level
Equal distribution of income creates an increment in consumption expenditure.
2. Level of tax:- A higher level of direct tax decreases the level of disposable income.
Therefore a decrease in disposable income decreases consumption level.
When the rate of direct tax lower disposable income rises, when it rises gives a chance for
consumption expenditure to increase.
3. Households future expectation of prices affects the level of consumption.
Expecting prices to rise, leads to a lower current consumption
Expecting prices to lower in the near future makes current consumption higher
4. Interest rate :- as interest is a reward for capital it has an inverse relationship with
consumption. Because households will become interested to save rather than increasing
consumption.
When interest rate increases ,consumption expenditure decrease by increasing the level of
saving
As interest rate decrease consumption expenditure increases by decreasing the level of saving.
5. Accumulated wealth effect:- With a higher accumulated wealth consumption expenditure
increases and vice versa .
8.1.2 Consumption function
Consumption function show the functional relationship between consumption and income.
C = f(Yd)
C = consumption expenditure
Yd= disposable income
F= consumption expenditure’s functional relationship with the level of disposable income.
The function shows that , it is dependent on the level of disposable income.
As we classified consumption into two main types the function will be elaborated as:-
C = a+ bYd
C = Consumption
a= Autonomous consumption
b = variable dependent on disposable income
byd=induced consumption which varies with the level of disposable income.
Example:-a given consumer’s consumption function is given by 50+0.5 Yd and the
consumer’s disposable income is 50,000 birr ,find the value for the following.
Required :- - Autonomous consumption
Induced consumption
Total consumption expenditure of the consumer.
The level of saving
Solution :- 1st Autonomous consumption
C=50 + 0.5Yd
Autonomous consumption is a consumption expenditure even if the disposable income is zero
meanwhile , if income is zero included consumption is zero therefore when we make disposable
income zero it would become simple to finds the value of autonomous consumption.
C=50 + 0.5 (0)
AC = 50 birr
2nd induced consumption
C = 50 + 0.5Yd
As induced consumption is a variable element in the function it is represented by 0.5Y d.
Induced consumption=0.5(5000)=2500 birr
3rd total consumption expenditure
C = 50 + 0.5 (Yd) ,C = 50 + 0.5 (5000)
C= 50 + 2500,C = 2550 Birr
Total consumption of the consumer becomes 2550 birr. And the money which is left from
consumption is saving
4th 5 level of saving
Yd =C +S
As we discussed earlier disposable income is divided into two:-
Consumption
Saving
Thus:-
5000 =2550 + 5
S =5000-2550
S = 2450 birr
Example 2. Assume the given consumers ,consumption function is given by 100
+ 0.75Yd and consumer’s disposable income is equal to 6000birr per month .Find
the value of the following.
Required :- Autonomous consumption expenditure
Induced consumption expenditure
Total consumption expenditure
The level of saving
Solution :- 1st Autonomous consumption expenditure
C=100 + 0.75Yd
Make disposable income zero to find the value of autonomous consumption
expenditure .
AC= 100 + 0.75 (0)
=100 birr
0.75 Yd
2nd induced consumption expenditure
C = 100 + Induced consumption IC = 0.75Yd
=0.75 (6,000)= 4500birr
4th level of saving
Yd =C + S ,S = Yd – C =6000 – 4500
=1500 birr
Consumption curve
•Consumption curve shows the relationship between consumption expenditure and disposable
income graphically.
Table 8.2 Consumption and income schedule
Level of national income (‘000) Consumption expenditure
0 50
100 100
200 150
300 200
400 250
500 30
Figure 8.1 Explains the following two important points

Consumption curve is an upward sloping curve showing a direct or positive
relationship between consumption expenditure and disposable income.
Consumption cannot be zero, on the curve is starts from50 unit, which refers to
income, is zero and consumption is positive.
I. Average propensity to consume
Average propensity to consume refers to the ratio of total consumption expenditure to
disposable income of a given consumer or national income level.
Average propensity to consume refers to the average tendency of consumers to spend their
portion of income towards consumption.
APC =
APC = average propensity to consume
C= consumption
Yd= disposable income
Example :- assume the national income level of a nation is 300million birr and the total
consumption expenditure accounts 150 million birr.
APC =
= 0.5 or 50%
The above figure shows consumers of that nation have an average tendency of spending
half of their income on consumption.
To illustrate APC in a table form:-
National Consumption APC
income expenditure
100 50 0.5
200 60 0.3
300 100 0.33
400 150 0.37
Table 8.3 APC schedule
APC curve
Refer the table on your text book
Figure 8.2 APC curve
The APC curve explains as disposable income increases average propensity to consume
decrease.
II. Marginal propensity to consume

Marginal propensity to consume is a ratio of change in consumption expenditure change in
disposable income.
It measures the tendency of consumers to spend the change in their disposable income on
consumption.
MPC =
MPC = marginal propensity to consume
C = Change in consumption
Yd = Change in disposable income
Example :- Assume the total consumption expenditure of an imaginary nation is change from
200million birr to 250million birr as a result of change in national income from 350 million birr
to 450 million birr.
MPC =
C = 250 – 200
=50million birr
Yd = 450 – 350
= 100 million birr
MPC == 0.5 or 50%
The tendency of consumers to change their consumption by 50% is as a result of change
in national income
If MPC is in between zero and the tendency of additional consumption does not reflect
the entire increments on income exhaustively spent.
Marginal propensity schedule
National Income Yd1(‘00) CX0 CX1 MPC

(Yd0) (‘000) (‘000) (‘000)
250 350 100 150 0.5
350 460 200 250 0.4
450 570 300 350 0.42
550 650 400 450 0.33
Table8.4 MPC schedule

On figure 8.4 with the increase in income marginal propensity to consume decrease
Marginal propensity to consume is a rate by which consumption changes as a result of
increase in income
On the above schedule national income increases showing a lesser rate of increment in
consumption than income
Note:- MPC is greater than zero but less than one to explain unequal increments in
consumption and income
MPC always decreases as national income increases
Review Question
1. State the definition of consumption?
____________________________________________________________________________
____________________________________________________________________________
2. How do you state the relationship between consumption and disposable income?
____________________________________________________________________________
____________________________________________________________________________
3. Consumption function is divided into two lists and defines their difference?
____________________________________________________________________________
____________________________________________________________________________
4. Calculate average propensity to consume in the table

National Income (Yd0) Consumption expenditure MPC
(‘000) (‘000)
100 50
120 60
140 70
160 80
5. Find the value of MPC when the addition to disposable income is 240million birr and change
consumption is 110 million birr?
____________________________________________________________________________
____________________________________________________________________________
6. Write the properties of APC curve
____________________________________________________________________________
____________________________________________________________________________
7. Explain marginal propensity to consume
____________________________________________________________________________
____________________________________________________________________________
Ydo Yd1 CX0 CX1 MPC
100 200 100 150

200 300 150 210
300 400 240 300
400 500 310 380
500 600 390 470
8. Find the value of MPX on the schedule using the information give in the table

’DO YOUR BEST AND STUDY’’’

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Chapter 8

The theory of Consumption, Saving and Investment

Yd Consumption (in money)

Figure 8.1 Explains the following two important points

II. Marginal propensity to consume

National Income Yd1(‘00) CX0 CX1 MPC

Table8.4 MPC schedule

100 200 100 150

’DO YOUR BEST AND STUDY’’’

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