CHAPTER 2
Aggregate Consumption and Saving
Chapter outline
• Meaning and concept of consumption.
• Consumption Function or propensity to consume.
• Concept of Saving..
• Motives for Saving.
1. Subjective consideration and
2. Objective consideration.
• Saving function or propensity to save
• Keynesian Psychological Law of Consumption
• Determinants of Consumption Function.
Concept of Consumption
• That part of consumers disposable income which is used to
spend on the general utilization of goods and services is
called consumption.
Generally income can be divided into two parts,
consumption and saving thus it can be shown as..
Y=C+S
C shows aggregate consumption which involve both all
private as well as government consumption expenditures in
a country.
Propensity to consume or
consumption function
• Consumption functions is a positive or direct relationship between
consumers disposable income and consumption. In other words,
consumption function indicates that consumption of consumers
depend on their level of income, more is the income, higher will be
the rate of consumption and vice versa. Consumption function is also
known as propensity to consume which is shown as..
• C = f (Y)
Two concept of consumption
function
An American economist J.M Keynes(1883-1946) developed two concepts for
propensity to consume or consumption function these are..
1. APC or ( Average Propensity to Consume) and
2. MPC or ( Marginal Propensity to Consume)
APC or Average Propensity to
Consume
• Average propensity to consume (APC) is defined as a ratio of
total consumption to total disposable income at different
levels. It is calculated by dividing the amount of
consumption by disposable income for any given level of
income. For example, when nation's disposable income is
Afs. 2000 billion and consumption expenditure is Afs. 1500
billion therefore, 1500/2000 = 0.75. this means that out of
2000 billion income , 75% will be used for consumption.
APC declines as income increases because the proportion
of income spent on consumption decreases as people tend
to save more out of increased income.
• APC = C/Y
Marginal propensity to consume or
(MPC)
• The concept of MPC is very important in macroeconomics , J.M
Keynes has defined marginal propensity to consume “ as the
relationship between a change in consumption (ΔC) that resulted
from a change in disposable income (ΔY). It is found out by dividing
change in consumption to a given change in disposable income.
MPC shows that how much of change in income is being consumed.
Thus
MPC = ΔC/ ΔY
Tabular explanation of APC and
MPC
Income (Y) Consumption (C ) Saving APC = C / Y MPC = ΔC / ΔY
100 100 0 1 0
200 150 50 0.75 0.5
300 200 100 0.66 0.5
400 250 150 0.645 0.5
Concept of Saving
• That part of households income which is not spent on consumption is
defined as saving. In other words, saving is the act of not consuming
all of one's current income or whatever is not consumed out of
disposable income is called saving. The economy's saving equation is
• Saving = Disposable income – consumption
or
S=Y–C
Motive for saving
• The motive for saving is divided into two major consideration..
1. Subjective considerations.
2. Objective consideration.
Subjective considerations
• Foresight : people save money as a provision against some
unforeseen circumstances which might arise in the future. A few
other accumulate wealth for their dependents, all such
consideration can be constituted under the heading foresight.
• Social considerations: wealth gives power over others in the
economic sphere and also political and social influence. The desire
of prestige, power and respect in social life actuates human being to
save.
Objective considerations.
• Security of life and property: if there is security of life and property in
a country, the saving is encouraged.
• Facilities for investment: if facilities of profitable investment are
available, then saving is stimulated.
Saving function
• Saving function or propensity to save is the direct or positive
relationship between saving and disposable income of individuals. In
other words saving is the function of income, as much as income is
increasing saving will also tend to increase and vice versa. Both
consumption and savings are positively correlated with the levels of
income. Higher is the income, more will be the tendency for
consumption and saving. Thus
• S = f (Y)
Concepts of saving function.
• APS ( Average Propensity to save )
• MPS or ( Marginal Propensity to save )
CONT`D
• Average propensity to Save (APS): the ratio of savings
to income
APS = S / Y
• Marginal propensity to Save: the ratio of change in
saving to change in income.
MPS = change in saving/ change in income
Note : MPC + MPS = 1
Keynesian Psychological Law of
Consumption
• J.M. Keynes in his book “ General Theory” analyzed the
consumption behavior of the community on the basis of human
behavior. He presented a Law which is known as Psychological
Law of Consumption. According to this Law, the level of
consumption in a community depends upon the level of
disposable income, as income increases, consumption also
increases but at a decreasing rate or it increases not as fast as
income. According to J.M. Keynes that as a psychological
behavior of people the increase in consumption is less than the
increase in income and this is what given as a Psychological Law
of consumption.
Properties to the Law of
Consumption
• The level of consumption is directly functionally related to
the level of disposable income.
C = f ( Y ).
• The rise in the level of consumption is less than the rise in
the level of income or consumption is increasing but at
decreasing rate.
ΔC < ΔY.
• As the level of income increases, the households devote a
part of incremental income to increase in consumption and
the other part to increase saving. Symbolically
ΔY = ΔC + ΔS