INTRODUCTION TO CONSUMPTION

Definition of Consumption
Economic Definition
Consumption, in economic terms, refers to the final purchase of goods and services by households for
their personal use. It represents the act of using up goods and services to satisfy human wants and needs.
In national income accounting, consumption is the largest component of aggregate demand, typically
accounting for 60-75% of GDP in most economies, including the Philippines.

Key Characteristics of Consumption

 **Final Use**: Goods and services are consumed directly, not used for further production
 **Household Sector**: Primarily undertaken by households and individuals
 **Immediate vs. Delayed**: Can be immediate (food, utilities) or delayed (durables like appliances)
 **Excludes**: Investment goods, government purchases, and net exports

Consumption in the Philippine Context

In the Philippines, household consumption expenditure consistently represents approximately 70-75% of
GDP. This high share indicates:

 Strong consumer-driven economy

 Large population base with active consumption
 Developing economy with growing middle class
 Importance of OFW remittances in supporting consumption

Philippine Example:

According to the Philippine Statistics Authority (PSA), in 2023, household final consumption expenditure
amounted to approximately ₱12.5 trillion, representing about 72% of the country's GDP. This includes
spending on food, housing, transportation, education, healthcare, and other personal goods and services.

Classifications of Consumption
A. By Type of Goods
1. Durable Goods

 Definition: Goods that provide utility over an extended period (usually more than 3 years)
 Characteristics: Expensive, purchased infrequently, can be resold
 Philippine Examples:

- Refrigerators and appliances

- Vehicles and motorcycles

- Computers and smartphones

- Furniture and home equipment

 Economic Significance: Durable goods purchases are highly sensitive to economic conditions and
interest rates

2. Non-Durable Goods

 Definition: Goods consumed quickly or used up in a short period

 Characteristics: Purchased frequently, cannot be stored long-term
 Philippine Examples:

- Food and beverages (rice, vegetables, meat)

- Clothing (though some argue clothing is semi-durable)

- Medicine and vitamins

- Gasoline and fuel

- Personal care products

 Economic Significance: Non-durable consumption is relatively stable during economic cycles

3. Services

 Definition: Intangible activities that provide value to consumers

 Characteristics: Cannot be stored, consumed at point of purchase
 Philippine Examples:

- Transportation services (jeepneys, buses, MRT/LRT)

- Education services (tuition fees)

- Healthcare services (doctor consultations)

- Communication services (mobile and internet)

- Personal services (haircuts, laundry, house cleaning)

 Economic Significance: Service consumption grows with economic development and urbanization

B. By Purpose
1. Essential Consumption (Basic Needs)

 Definition: Consumption required for basic survival and minimum standard of living
 Characteristics: Inelastic demand, priority in budget allocation
 Philippine Examples:

- Rice and basic food items

- Basic shelter (rent or mortgage)

 - Essential utilities (electricity, water)

- Basic clothing

- Essential medicines

 Economic Significance: Forms the base of the consumption pyramid, first to be allocated in
household budgets

2. Discretionary Consumption

 Definition: Consumption that enhances quality of life but is not essential

 Characteristics: More elastic, varies with income levels
 Philippine Examples:

- Dining at restaurants

- Entertainment (movies, concerts)

- Vacations and travel

- Luxury items

- Upgraded electronics

 Economic Significance: Increases with income growth and economic prosperity

3. Luxury Consumption

 Definition: High-end consumption beyond normal needs

 Characteristics: Very elastic, status-oriented, small portion of population
 Philippine Examples:

- Luxury vehicles

- High-end fashion brands

- Premium real estate

- Expensive jewelry and watches

 Economic Significance: Concentrated among high-income groups, sensitive to economic conditions

Additionally:

Autonomous Consumption

Autonomous consumption is the level of consumption that occurs even when income is zero.

It does not depend on current income.

Even if income is zero, people still need:

 Food

 Shelter

 Utilities

 Basic transportation

They finance this through:

 Savings

 Borrowing

 Credit

 Assistance (family, government aid)

Induced Consumption

Induced consumption is the portion of consumption that changes with income.

It depends directly on income.

Why is it called “induced”?: Because it is induced by income changes.

If income increases → consumption increases.

If income decreases → consumption decreases.

The Role of Consumption in National Income Accounting

Components of Aggregate Demand
GDP = C + I + G + (X - M)

Where:

 C = Consumption
 I = Investment
 G = Government spending
 (X - M) = Net exports

Why Consumption Matters

**Largest Component**: Typically 60-75% of GDP in most economies
**Economic Indicator**: Reflects household confidence and economic health
**Multiplier Effect**: Changes in consumption have magnified effects on GDP
**Policy Target**: Government policies often aim to influence consumption
Philippine Data Analysis:

Year Household GDP (₱ Billions) Share of GDP

Consumption (₱
Billions)

2019 10,847 15,933 68.1%

2020 9,987 14,643 68.2%

2021 10,889 15,564 70.0%

2022 12,012 17,262 69.6%

2023 12,547 17,435 72.0%

Expenditure Category Share of Total

Expenditure (All Families)

Food 42.1%

Housing 21.3%

Transportation 8.7%

Education 4.2%

Health 3.8%

Clothing 2.9%

Communication 2.5%

Recreation 1.8%

Miscellaneous 12.7%

HOUSEHOLD CONSUMPTION BEHAVIOR

Family Budget and Expenditure
Understanding the Family Budget
A family budget is a financial plan that outlines expected income and planned expenditure over a specific
period. It reflects household priorities, constraints, and consumption patterns.

Elements of a Family Budget

Income Components:
**Wages and Salaries**: Regular employment income
**Remittances**: Money from OFW family members (significant in Philippines)
**Business Income**: Income from small businesses or self-employment
**Investment Income**: Dividends, interest, rental income
**Government Transfers**: Pensions, social benefits, conditional cash transfers

Expenditure Components:

**Food and Non-Alcoholic Beverages**: Usually the largest expense for Filipino households
**Housing and Utilities**: Rent/mortgage, electricity, water, gas
**Transportation**: Public transport, fuel, vehicle maintenance
**Education**: Tuition fees, school supplies, books
**Health**: Medicines, hospital bills, health insurance
**Communication**: Mobile load, internet subscriptions
**Clothing and Footwear**: Regular purchases
**Recreation and Culture**: Entertainment, hobbies
**Miscellaneous**: Personal care, household items
**Savings**: Portion of income set aside for future use

Philippine Household Expenditure Patterns

Based on Family Income and Expenditure Survey (FIES) 2021:

Key Observations:

 Food remains the largest expenditure category despite economic growth

 Housing costs have increased due to urbanization
 Education spending reflects high value placed on education
 Transportation costs vary significantly between urban and rural areas

Budget Allocation Principles

1. The 50-30-20 Rule

 50% for needs (essentials)

 30% for wants (discretionary)
 20% for savings and debt repayment

Note: This may be challenging for low-income Filipino households where needs exceed 50%

2. Maslow's Hierarchy Approach

 First allocate for physiological needs (food, shelter)

 Then safety needs (healthcare, insurance)
 Then belonging needs (social activities)
 Then esteem needs (education, self-improvement)
 Finally, self-actualization (luxury items, hobbies)

3. Priority-Based Allocation
  Essential needs (non-negotiable)
 Debt obligations (if any)
 Important goals (education, health)
 Savings and emergency fund
 Discretionary spending
 Luxury purchases

Budget Constraints and Optimization

The Budget Constraint

Given limited income, households must allocate resources efficiently. The budget constraint is
represented as:

I = P₁Q₁ + P₂Q₂ + P₃Q₃ + ... + PₙQₙ

Where:

 I = Total income
 P₁, P₂, P₃... = Prices of goods
 Q₁, Q₂, Q₃... = Quantities purchased

Utility Maximization

Households aim to maximize utility (satisfaction) subject to their budget constraint. This involves:

 Making trade-offs between different goods

 Prioritizing purchases that provide the most satisfaction per peso
 Considering both present and future needs

Real-World Philippine Example:

Scenario: The Santos Family

 Total Monthly Income: ₱25,000

 Family Composition: 4 members (2 adults, 2 children)

Monthly Budget Allocation:

**Food**: ₱8,000 (32%)

- Rice and groceries: ₱5,000

- Meat and vegetables: ₱2,000

- Snacks and beverages: ₱1,000

**Housing**: ₱5,000 (20%)

- Rent: ₱4,000

- Electricity: ₱700

- Water: ₱300

**Transportation**: ₱3,000 (12%)

- Jeepney fare: ₱2,000

- Tricycle and occasional taxi: ₱1,000

**Education**: ₱2,000 (8%)

- School fees: ₱1,500

- School supplies: ₱500

**Health**: ₱1,500 (6%)

- Medicines and vitamins: ₱1,000

- Emergency fund: ₱500

**Communication**: ₱500 (2%)

- Mobile load and internet: ₱500

**Clothing**: ₱500 (2%)

- Occasional clothing purchases

**Savings**: ₱2,500 (10%)

- Emergency fund: ₱1,500

- Future goals: ₱1,000

**Miscellaneous**: ₱2,000 (8%)

- Personal care: ₱500

- Household items: ₱500

- Occasional treats: ₱1,000

Total: ₱25,000

This budget allocation reflects typical Filipino middle-class priorities, with significant portions allocated
to food and housing, while maintaining some savings.
Break-Even Point
Definition
The break-even point in consumption analysis refers to the income level at which total consumption
equals total income. At this point, households spend exactly all their income, with no saving or dissaving.

Mathematical Expression:

At break-even point:

C=Y

S=0

Where:

 C = Consumption
 Y = Income
 S = Saving

Graphical Representation
Consumption (C)

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+------------------- Income (Y)
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BEP (Break-Even Point)

The break-even point occurs where the consumption curve intersects the 45° line (where C = Y).

Determining the Break-Even Point

Using Linear Consumption Function:

C = a + bY

Where:

 a = Autonomous consumption (consumption when Y = 0)

 b = Marginal propensity to consume (MPC)

At break-even point:

Y = a + bY

Y - bY = a

Y(1 - b) = a

Y = a / (1 - b)

Example:

Given consumption function: C = ₱5,000 + 0.75Y

At break-even point:

Y = 5,000 + 0.75Y

Y - 0.75Y = 5,000

0.25Y = 5,000

Y = 5,000 / 0.25

Y = ₱20,000

Therefore, at income of ₱20,000, consumption equals income (C = ₱20,000) and saving is zero.

Practice Problem 1:

If a household's consumption function is C = ₱8,000 + 0.80Y, at what income level will they break even?

Solution:

Y = 8,000 / (1 - 0.80)

Y = 8,000 / 0.20

Y = ₱40,000

Practice Problem 2:

The Reyes family earns ₱30,000 monthly and spends ₱27,500. Are they above or below the break-even
point? By how much?

Solution:

Income > Consumption, so they are above break-even point.

Saving = Y - C = 30,000 - 27,500 = ₱2,500

SAVING: DEFINITION AND CLASSIFICATIONS
Definition of Saving
Economic Definition
Saving is defined as the portion of disposable income that is not spent on consumption. It represents
income that is set aside for future use rather than current consumption.

Mathematical Expression:

S=Y-C

Where:

 S = Saving
 Y = Disposable Income (after-tax income)
 C = Consumption

Relationship to Consumption:

Since Y = C + S, then S = Y - C

Importance of Saving in Economic Growth

1. Capital Formation

 Savings provide funds for investment

 Investment leads to capital accumulation
 More capital increases production capacity
 Higher production supports economic growth

2. Financial Intermediation

 Banks collect savings and lend to investors

 Financial markets channel savings to productive uses
 Efficient allocation of resources

3. Economic Stability

 High savings rate reduces vulnerability to shocks

 Provides buffer during economic downturns
 Reduces reliance on foreign borrowing

4. Long-term Development

 Enables large-scale investments

 Funds infrastructure development
 Supports technology adoption
Philippine Saving Rate:

The Philippines has historically had a relatively low saving rate compared to other Asian economies. In
recent years, the gross domestic saving rate has been around 20-25% of GDP, lower than China (40-
45%), Singapore (45-50%), and Thailand (30-35%).

Classifications of Saving
A. By Source
1. Personal Saving (Household Saving)

 Definition: Saving by households from disposable income

 Calculation: Disposable income - Consumption
 Philippine Context: OFW remittances significantly boost household saving capacity
 Example: A family saving ₱5,000 monthly from ₱30,000 income

2. Business Saving

 Definition: Retained earnings of businesses not distributed as dividends

 Sources: Corporate profits, depreciation allowances
 Philippine Context: Large corporations and SMEs contribute to national saving
 Example: A corporation retaining ₱10 million of profit for expansion

3. Government Saving

 Definition: Budget surplus (revenue > expenditure)

 Note: Most governments, including Philippines, have budget deficits (negative saving)
 Philippine Context: Government usually runs deficit, reducing national saving
 Example: If government collects ₱3 trillion and spends ₱3.5 trillion, saving = -₱0.5 trillion

B. By Purpose
1. Precautionary Saving

 Definition: Saving for emergencies and unexpected events

 Motivation: Uncertainty about future income or expenses
 Philippine Examples:

- Emergency medical fund

- Job loss protection

- Natural disaster preparation

- Pandemic-related savings (evident during COVID-19)

2. Investment Saving

 Definition: Saving specifically for future investment

 Motivation: Capital accumulation, business expansion, education
 Philippine Examples:

- Saving for college education

- Saving for business startup

- Saving for down payment on property

3. Retirement Saving

 Definition: Saving for post-retirement years

 Motivation: Income replacement after retirement
 Philippine Examples:

- SSS contributions

- Pag-IBIG Fund savings

- Private retirement plans

- Personal retirement savings

4. Targeted Saving

 Definition: Saving for specific future purchases

 Motivation: Large planned expenditures
 Philippine Examples:

- Saving for house construction

- Saving for vehicle purchase

- Saving for vacation/travel

C. Alternative Measures of Saving

1. Gross Saving vs. Net Saving

Gross Saving:

 Definition: Total saving before deducting depreciation

 Calculation: Gross domestic income - Consumption
 Philippine Context: Used in national accounts
 Formula: Gross Saving = Gross Domestic Income - Final Consumption Expenditure

Net Saving:

 Definition: Gross saving minus depreciation of capital

 Calculation: Gross Saving - Depreciation
 Philippine Context: Better measure of true increase in wealth
 Significance: Shows actual increase in productive capacity

Example:

 Gross saving: ₱5 trillion

 Depreciation: ₱2 trillion
 Net saving: ₱3 trillion

2. National Saving

 Definition: Total saving by all sectors of the economy

 Components: Household saving + Business saving + Government saving
 Calculation: National Saving = Gross Domestic Saving
 Philippine Context: Aggregate measure of economy's saving capacity
 Importance: Determines domestic funds available for investment

Formula:

National Saving = (Y - T - C) + (T - G)

Where:

 Y = GDP
 T = Taxes
 C = Consumption
 G = Government spending

Simplified:

National Saving = Private Saving + Public Saving

Private Saving = Y - T - C

Public Saving = T - G

3. Household Saving Rate

 Definition: Percentage of disposable income saved by households

 Calculation: (Household saving / Disposable income) × 100%
 Philippine Context: Historically low, around 10-15% of disposable income
 Comparison: Lower than many Asian neighbors but higher than some Western countries
RELATIONSHIP BETWEEN INCOME, CONSUMPTION, AND
SAVING
Fundamental Relationship
The Identity
The most fundamental relationship in macroeconomics between income, consumption, and saving is
expressed as:

Y=C+S

Where:

 Y = Disposable Income
 C = Consumption
 S = Saving

This identity states that all disposable income must be either consumed or saved.

Implications of the Identity

1. If one component is known, the other can be calculated:

 S=Y-C
 C=Y-S

2. The relationship is always true by definition:

 It's an accounting identity, not a behavioral equation

 Based on the definition of saving as income not consumed

3. The relationship changes with income level:

 Both C and S generally increase with Y

 The proportions of Y allocated to C and S change with income level

Consumption Function
Definition
The consumption function is a mathematical relationship that shows how consumption expenditure varies
with disposable income. It was developed by John Maynard Keynes and is a fundamental concept in
macroeconomics.

Keynes' Fundamental Psychological Law

"Men are disposed, as a rule and on the average, to increase their consumption as their income increases,
but not by as much as the increase in their income."

Key points:
  Consumption increases with income
 But consumption increases less than income
 Therefore, saving increases with income

Linear Consumption Function

General Form:

C = a + bY

Where:

 C = Consumption expenditure
 a = Autonomous consumption (consumption when Y = 0)
 b = Marginal Propensity to Consume (MPC)
 Y = Disposable income

Components Explained:

1. Autonomous Consumption (a)

 Definition: Minimum consumption that occurs even when income is zero

 Explanation: Households must consume even with no income (basic survival)
 How it's financed: Borrowing, using past savings, government assistance, family support
 Philippine Example: Poor families borrowing or relying on family help even with zero income

2. Induced Consumption (bY)

 Definition: Consumption that depends on and is induced by income level

 Increases as income increases
 Philippine Example: A family spends more on food, clothing, and other items when income increases

3. Marginal Propensity to Consume (b or MPC)

 Definition: Change in consumption resulting from a change in income

 Formula: MPC = ΔC / ΔY
 Range: 0 < MPC < 1 (consumption increases less than income)
 Philippine Context: MPC is typically higher for low-income households

Properties of Consumption Function

1. Slope:

 The slope of the consumption function is the MPC

 Slope = ΔC / ΔY = MPC
 Must be positive (C increases with Y) and less than 1 (C increases less than Y)

2. Intercept:
 The y-intercept is autonomous consumption (a)
 Positive value (consumption occurs even at zero income)

3. Position:

 Consumption function starts above origin (positive intercept)

 Lies above the 45° line for low incomes
 Eventually intersects and may cross the 45° line (depends on parameters)

4. Shape:

 For linear consumption function: straight line

 For non-linear functions: can be concave or convex to origin

Graphical Representation
Consumption (C)

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+------------------- Income (Y)
0
a = Autonomous consumption

Savings Function
Definition
The savings function shows the relationship between saving and disposable income. It is derived from the
consumption function and the fundamental identity Y = C + S.

Derivation from Consumption Function

Given:

Y=C+S
C = a + bY
Substituting (2) into (1):

Y = a + bY + S

S = Y - a - bY

S = -a + Y - bY

S = -a + (1 - b)Y

Therefore, the savings function is:

S = -a + (1 - b)Y

Where:

 S = Saving
 a = Autonomous consumption (from consumption function)
 b = MPC (from consumption function)
 (1 - b) = Marginal Propensity to Save (MPS)
 Y = Disposable income

Components of Savings Function

1. Autonomous Saving (-a)

 Definition: Saving when income is zero

 Negative value (-a) because households consume even at zero income
 Represents dissaving at zero income
 Philippine Example: Poor households borrow or deplete savings when income is zero

2. Induced Saving [(1 - b)Y]

 Definition: Saving that depends on income level

 Increases as income increases
 Proportion depends on MPS (1 - b)

3. Marginal Propensity to Save (MPS)

 Definition: Change in saving resulting from change in income

 Formula: MPS = ΔS / ΔY = 1 - MPC
 Relationship: MPS = 1 - MPC
 Range: 0 < MPS < 1
Properties of Savings Function
1. Slope:

 The slope of the savings function is MPS

 Slope = ΔS / ΔY = MPS = 1 - MPC
 Positive slope (saving increases with income)
 Less steep than consumption function if MPC > 0.5

2. Intercept:

 The y-intercept is -a (negative)

 Saving is negative when Y = 0

3. Shape:

 Straight line (linear savings function)

 Starts below origin (negative intercept)
 Crosses horizontal axis at break-even point

Graphical Representation
Saving (S)

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|/_______________________
| | | | Income (Y)
-a 0 BEP

Using the Functions Together

Example: Economic Analysis

Given:

C = ₱10,000 + 0.70Y

S = -₱10,000 + 0.30Y
Analysis:

**At Y = ₱50,000:**

- C = 10,000 + 0.70(50,000) = 10,000 + 35,000 = ₱45,000

- S = -10,000 + 0.30(50,000) = -10,000 + 15,000 = ₱5,000

- Check: C + S = 45,000 + 5,000 = ₱50,000 = Y ✓

**Break-even point:**

- Set S = 0: -10,000 + 0.30Y = 0

- 0.30Y = 10,000

- Y = 10,000 / 0.30 = ₱33,333

- Verify: C = 10,000 + 0.70(33,333) = 10,000 + 23,333 = ₱33,333 ✓

**If income increases by ₱10,000:**

- Consumption increases by: ΔC = MPC × ΔY = 0.70 × 10,000 = ₱7,000

- Saving increases by: ΔS = MPS × ΔY = 0.30 × 10,000 = ₱3,000

- Check: ΔC + ΔS = 7,000 + 3,000 = ₱10,000 = ΔY ✓

Key Formulas:

 Fundamental identity: Y = C + S
 Consumption function: C = a + bY
 Savings function: S = -a + (1 - b)Y
 MPC + MPS = 1
 Break-even income: Y = a / (1 - b)

Key Concepts:

 Consumption and saving functions show how spending and saving vary with income
 MPC is the slope of consumption function
 MPS is the slope of savings function
 Break-even point is where consumption equals income (saving = 0)
 Both consumption and saving increase with income, but at different rates
PROPENSITY TO CONSUME AND SAVE
Average Propensity to Consume (APC)
Definition
The Average Propensity to Consume (APC) is the ratio of total consumption expenditure to total
disposable income. It indicates what proportion of income is spent on consumption.

Formula
APC = C / Y

Where:

 APC = Average Propensity to Consume

 C = Total consumption expenditure
 Y = Total disposable income

Interpretation
 APC shows the fraction of income spent on consumption
 APC > 1: Consumption exceeds income (dissaving)
 APC = 1: All income is consumed (break-even)
 APC < 1: Part of income is saved

Behavior of APC
1. APC Decreases with Income:

 As income increases, APC typically decreases

 Higher income households save a larger proportion of income
 Reflects diminishing marginal propensity to consume

2. Range:

 Can be greater than 1 for low-income households (dissaving)

 Approaches a lower limit as income becomes very high
 Typically ranges from 0.5 to 1.2 for most households

3. Economic Significance:

 Higher APC: More consumption-oriented society

 Lower APC: More saving-oriented society
 Affects aggregate demand and economic growth
Numerical Example: Philippine Household
Scenario: The Cruz Family

Analysis:

 2018: APC = 1.10 (dissaving, likely borrowed or used savings)

 2019-2022: APC < 1 (positive saving)
 APC decreases as income increases (from 0.90 to 0.75)
 Higher income → lower APC (more saving)

Average Propensity to Save (APS)

Definition
The Average Propensity to Save (APS) is the ratio of total saving to total disposable income. It indicates
what proportion of income is saved.

Formula
APS = S / Y

Where:

 APS = Average Propensity to Save

 S = Total saving
 Y = Total disposable income

Alternative Formula:

Since Y = C + S

APS = (Y - C) / Y = 1 - (C / Y) = 1 - APC

Interpretation
 APS shows the fraction of income saved
 APS < 0: Negative saving (dissaving)
 APS = 0: No saving (break-even)
 APS > 0: Positive saving

Relationship Between APC and APS

Key Identity:

APC + APS = 1

Derivation:
APC + APS = (C / Y) + (S / Y) = (C + S) / Y = Y / Y = 1

Implications:

If APC increases, APS must decrease

If APC = 1, then APS = 0
If APC > 1, then APS < 0
The two propensities are complements

Numerical Example: Continuing the Cruz Family

Key Observations:

APS = 1 - APC (e.g., 0.25 = 1 - 0.75)

APC + APS always equals 1
APS increases as income increases (from -0.10 to 0.25)
APS mirrors APC in opposite direction

Marginal Propensity to Consume (MPC)

Definition
The Marginal Propensity to Consume (MPC) measures the change in consumption resulting from a
change in income. It indicates how much of additional income is spent on consumption.

Formula
MPC = ΔC / ΔY

Where:

 MPC = Marginal Propensity to Consume

 ΔC = Change in consumption
 ΔY = Change in income

Interpretation
 MPC shows the fraction of additional income consumed
 MPC = 0.75: For every ₱1 increase in income, consumption increases by ₱0.75
 MPC ranges between 0 and 1 (exclusive)

Range and Significance

*Range: 0 < MPC < 1

 Cannot be 0: Some consumption always occurs

 Cannot be 1: Not all additional income is consumed (some is saved)
 Typically between 0.5 and 0.9 for households

Economic Significance:
**Higher MPC:** More responsive consumption to income changes
**Lower MPC:** Less responsive consumption
**Key Determinant:** Determines multiplier effect in economy
**Policy Relevance:** Affects fiscal policy effectiveness

Factors Affecting MPC

1. Income Level:

 Lower income → Higher MPC (need to spend most additional income)

 Higher income → Lower MPC (can save more)

2. Access to Credit:

 Easy credit → Higher MPC (can borrow to consume)

 Limited credit → Lower MPC (must finance consumption from income)

3. Interest Rates:

 Higher rates → Lower MPC (incentive to save)

 Lower rates → Higher MPC (incentive to consume)

4. Consumer Confidence:

 High confidence → Higher MPC (willing to spend)

 Low confidence → Lower MPC (prefer to save)

5. Demographics:

 Young families → Higher MPC (many needs)

 Elderly → Higher MPC (spending from savings)
 Prime working age → Lower MPC (saving for future)

Observed MPC Values in the Philippines:

**Low-income households:** 0.85-0.95 (high MPC, spend most additional income)

**Middle-income households:** 0.70-0.85 (moderate MPC)
**High-income households:** 0.50-0.70 (lower MPC, save more)
**Urban households:** 0.65-0.80
**Rural households:** 0.75-0.90

Factors Influencing Philippine MPC:

High poverty rate → High MPC among poor

Large informal economy → Variable MPC
OFW remittances → Affect household MPC
Cultural factors → Strong family support affects MPC
Marginal Propensity to Save (MPS)
Definition
The Marginal Propensity to Save (MPS) measures the change in saving resulting from a change in
income. It indicates how much of additional income is saved.

Formula
MPS = ΔS / ΔY

Where:

 MPS = Marginal Propensity to Save

 ΔS = Change in saving
 ΔY = Change in income

Alternative Formula:

Since Y = C + S

ΔY = ΔC + ΔS

Divide by ΔY: 1 = (ΔC/ΔY) + (ΔS/ΔY) = MPC + MPS

Therefore: *MPS = 1 - MPC*

Interpretation
 MPS shows the fraction of additional income saved
 MPS = 0.25: For every ₱1 increase in income, saving increases by ₱0.25
 Ranges between 0 and 1 (exclusive)

Relationship Between MPC and MPS

Key Identity:

MPC + MPS = 1

Implications:

If MPC = 0.75, then MPS = 0.25

If MPC increases, MPS must decrease
Both are determined by household preferences and constraints
Sum always equals 1

Economic Significance:

High MPC + Low MPS: Consumption-driven economy

Low MPC + High MPS: Saving-driven economy
Affects economic growth patterns
For Linear Savings Function:
S = -a + (1 - b)Y
Where (1 - b) = MPS = 1 - MPC

Example:
C = ₱8,000 + 0.75Y
S = -₱8,000 + 0.25Y
MPC = 0.75
MPS = 0.25

When to Use Which

Use APC/APS when:

 Analyzing current household consumption patterns

 Comparing different households or countries
 Understanding overall economic structure
 Analyzing income distribution effects

Use MPC/MPS when:

 Predicting effects of income changes

 Analyzing policy impacts (tax cuts, stimulus)
 Understanding multiplier effects
 Short-term economic forecasting

The Multiplier Effect

Concept
The multiplier effect shows how an initial change in spending leads to a larger change in national income.
MPC is a key determinant of the multiplier size.

Simple Multiplier Formula

k = 1 / (1 - MPC) = 1 / MPS

Where:

 k = Multiplier
 MPC = Marginal Propensity to Consume
 MPS = Marginal Propensity to Save

Interpretation
 Higher MPC → Higher multiplier (more rounds of spending)
 Lower MPC → Lower multiplier (more saving, less spending)
 Multiplier shows how much total income increases from an initial injection

Numerical Example
Scenario: Government Stimulus Spending
Case 1: MPC = 0.80

 Multiplier k = 1 / (1 - 0.80) = 1 / 0.20 = 5

 Initial spending: ₱100 billion
 Total increase in GDP: 5 × ₱100 billion = ₱500 billion

Case 2: MPC = 0.60

 Multiplier k = 1 / (1 - 0.60) = 1 / 0.40 = 2.5

 Initial spending: ₱100 billion
 Total increase in GDP: 2.5 × ₱100 billion = ₱250 billion

*Conclusion: Higher MPC leads to larger multiplier effect, making fiscal policy more effective.

SUMMARY CHECKPOINT
Key Formulas:

 APC = C / Y
 APS = S / Y = 1 - APC
 MPC = ΔC / ΔY
 MPS = ΔS / ΔY = 1 - MPC
 APC + APS = 1
 MPC + MPS = 1
 Multiplier: k = 1 / (1 - MPC) = 1 / MPS

NATIONAL CONSUMPTION BEHAVIOR - PHILIPPINE

CONTEXT
National Consumption Function
Definition
The national consumption function is the aggregate relationship between total national consumption and
total national disposable income. It represents the consumption behavior of all households in the economy
combined.

Aggregate Consumption Function

C = a + bYd

Where:

 C = Aggregate consumption expenditure

 a = Aggregate autonomous consumption
 b = Aggregate marginal propensity to consume
 Yd = Aggregate disposable income
National Consumption Characteristics
1. Consumption as the Largest GDP Component
 Consistently 68-72% of GDP
 Larger than investment (15-25%) and government spending (12-18%)
 Shows consumption-driven economy

2. High Food Share

 Food expenditure accounts for 40-45% of total consumption
 Higher than most developed countries (10-15%)
 Reflects Engel's Law: As income rises, food share decreases

3. Urban-Rural Consumption Gap

 Urban consumption per capita: 2-3× rural consumption
 Urban areas: More diversified consumption, more services
 Rural areas: More basic goods, less services

4. Remittance-Driven Consumption
 OFW remittances boost household consumption
 Remittances provide stable income source
 Affects consumption patterns (more durable goods, education)

5. Informal Sector Influence

 Large informal economy affects consumption measurement
 Many transactions unrecorded but significant
 Challenges in accurate data collection

6. Seasonal Patterns
 Higher consumption during December (holiday season)
 Lower consumption in some agricultural regions during off-season
 School opening affects consumption patterns

Determinants of National Consumption

A. Income Level
1. Disposable Income (Yd)

 Primary determinant of consumption

 Higher Yd → Higher consumption
 Philippine Context:

- Real GDP growth: 5-7% annually (pre-pandemic)

- Per capita income: ~₱180,000 annually (~$3,200)

 - Income distribution: Highly unequal (Gini coefficient ~0.40)

2. Permanent Income

 Long-term average income expected to persist

 More important than current income for consumption decisions
 Philippine Context:

- OFWs provide more stable permanent income

- Informal sector income more volatile

- Government jobs provide stable permanent income

3. Expected Future Income

 Anticipated changes in income affect current consumption

 Philippine Context:

- Young professionals expect rising income (higher consumption)

- Near-retirement expect declining income (lower consumption)

- Job market uncertainty affects consumption

B. Interest Rates
Effect on Consumption:

 Higher interest rates → Lower consumption (substitution effect)

 Higher interest rates → Higher consumption (income effect for savers)
 Net effect: Usually negative on consumption

Philippine Context:

 BSP sets policy rates (currently 4.00-6.25% range)

 Higher interest rates reduce:

- Vehicle purchases (financing)

- Housing (mortgages)

- Durable goods (credit purchases)

 Lower interest rates stimulate consumption

C. Consumer Confidence
Consumer Confidence Index (CCI):

 Measures optimism about economy

 Affects willingness to spend
 Philippine Context:

- CCI varies with economic conditions

- Pandemic: Low confidence, reduced consumption

- Recovery: Improving confidence, increased consumption

Factors Affecting Consumer Confidence:

 Economic growth prospects

 Employment outlook
 Inflation expectations
 Political stability
 Global economic conditions

D. Wealth Effects
Definition:

Changes in wealth affect consumption

Higher wealth → Higher consumption

Philippine Wealth Effects:

 **Real Estate:**

- Property values affect consumption

- Rising property prices → Higher consumption (wealth effect)

- Housing bubble concerns

**Stock Market:**

- PSEI (Philippine Stock Exchange Index) affects wealth

- Stock market gains → Higher consumption

- Limited effect (only 2-3% of Filipinos own stocks)

**OFW Remittances:**

- Major source of household wealth

- Remittances = $30-35 billion annually

- Boosts consumption significantly

Example:
Family receives ₱1 million remittance:

 Immediate consumption: Food, education, housing

 Durable goods: Appliances, vehicles
 Saving: Part of remittance saved
 Overall consumption increases

E. Demographic Factors
1. Age Structure:

 Young population: Higher consumption (childcare, education)

 Working age: Peak consumption
 Elderly: Higher medical consumption, lower overall

Philippine Demographics:

 Median age: 25-26 years

 Large young population (0-14: ~30%)
 Growing working-age population (15-64: ~63%)
 Implications: High consumption growth potential

2. Household Size:

 Average household size: 4-5 members

 Larger households: Different consumption patterns
 Economies of scale in consumption

3. Urbanization:

 Urban population: ~50% and growing

 Urban consumption: More services, more variety
 Rural consumption: More basic goods

F. Government Policies and Taxation

1. Fiscal Policy:

 Government spending affects income and consumption

 Tax reforms affect disposable income

Philippine Examples:

 TRAIN Law (2017): Lower income taxes, higher consumption

 Pantawid Pamilyang Pilipino Program (4Ps): Direct cash transfers
 Emergency cash transfers during pandemic

2. Social Protection:
 4Ps program benefits ~4 million households
 Boosts consumption of poorest families
 Reduces poverty, increases consumption

3. Subsidies:

 Fuel subsidies affect transportation costs

 Rice subsidies affect food prices
 Indirectly affect consumption

G. Cultural Factors
1. Family Orientation:

 Strong family ties affect consumption

 Multi-generational households
 Shared consumption

2. Social Spending:

 Fiestas, celebrations, gatherings

 Social expectations affect spending
 Pressure to conform

3. OFW Culture:

 OFW families have different consumption patterns

 More education spending
 More durable goods
 Higher consumption overall

4. Religious Influence:

 Catholic tradition affects consumption

 Christmas spending (13th month pay, bonuses)
 Lenten season reduces some consumption

Sectoral Consumption Distribution

Household Consumption by Category (2023):

Key Insights:

 Food remains largest category (42.1%)

 Housing is second largest (21.3%)
 Fastest growing: Recreation and Culture (+10.2%)
 Education spending growing rapidly (+8.5%)