Lecture on Consumption Function

Introduction

• Good afternoon everyone.
• Today's lecture is going to be fun and engaging.
• Keep your mind open and think to understand the concepts.

Main Topic: Consumption Function

• Consumption function is part of aggregate demand.
• Aggregate demand is composed of consumption expenditure and investment expenditure.
• In the short term, investment expenditure is considered constant.
• Focus is on consumption expenditure.

Key Concepts

Consumption Function

• Dependent on income: Aggregate consumption expenditure is a function of disposable income.
• Relationship: Examined between consumption and disposable income.
• Consumption (C): Expenditure dependent on income.
• Disposable Income (YD): Income after taxes.

Mathematical Representation

• Equation: C = A + BYD
  • C: Consumption expenditure
  • A: Autonomous consumption
  • B: Marginal propensity to consume (MPC)
  • YD: Disposable income

Autonomous Consumption (A)

• Exists even at nil income: Necessary expenses (e.g., food, shelter).
• Example: Expenses you incur even if you have no income, such as rent, basic food.
• Source: Savings or borrowing if no income.

Marginal Propensity to Consume (MPC)

• Definition: The additional consumption due to an increase in disposable income.
• Value: Between 0 and 1
  • 0 < MPC < 1
  • Not 0: Consumption increases with income.
  • Not 1: Not all income is spent; some is saved.
• Example: If income increases, consumption increases but not proportionally.
• Formula: Change in consumption / Change in income

Behavioral Insights

• Behavior: Rational consumers save a portion of increased income.
• Example: If income increases from 50,000 to 75,000, consumption increases less than 25,000.
• Savings: Part of increased income is saved.

Additional Notes

• Theory by Keynes: Consumption function proposed by Keynes.
• Slope Function: Change in consumption upon change in income also referred to as the slope function.

Summary

• Aggregate demand consists of consumption and investment expenditure.
• Consumption function: Focus on how consumption varies with disposable income.
• MPC: Key metric to understand consumption behavior.
• Autonomous Consumption: Represents necessary spending at zero income.
• Rational Behavior: Consumers save part of increased income; thus, consumption increases less than income.

Lecture Conclusion

• Understanding MPC: Critical for understanding how consumption and income interact.
• Next Session: Continue diving deeper into related concepts.