Level of Output and Income, Consumption, Saving, APC, APS, MPC, MPS the new level of consumption at the $ billion level of disposable income? from Praxis Family & Consumer Sciences (): Practice & Study Guide Consumption Function: Relationship Between Marginal & Average Propensity to Consume. Basic Macroeconomic Relationships. the Consumption Function (CF), reflects the direct consumption-disposable income relationship (this is. Relationship between Disposable Income and Consumption! People can either spend or save their disposable income. When people are very poor, they cannot .
None of these occurrences increases your income, but they all increase your wealth. An increase in wealth will increase your consumption even at the same income level, and can be illustrated by an upward shift in both the Consumption Function and the Savings Function. Obviously, a decrease in wealth will have the opposite effect. Expectations—There are times when consumers adjust their spending, based not on their actual income but rather on their expectations of future changes in their income.
Changes in expectations will cause a shift in the curve, because consumption has changed without an actual chance in income. For example, if you think your income is going to go up in the future, you may consume more today. Not that we suggest this as a wise course of action, but it has been observed that some college seniors start to spend more once they have secured a job, even though that job and its attendant income will not start for a month or two.
This behavior would be illustrated by an upward shift in the consumption function showing that your consumption has increased even though your actual disposable income has not.
Likewise, if for some reason you were pessimistic about your future income rumors floating around the company that layoffs were eminent you might decrease your consumption, even though your actual current income had not changed. Consumer Indebtedness—Consumers adjust their consumption to levels of indebtedness as well. We observe in the aggregate economy that when indebtedness goes up, consumption falls and savings rise. There is a level of debt beyond which consumers feel uncomfortable with additional spending.
Even if income has stayed the same, if too much debt accumulates, consumers will start to spend less and pay off debt. This is illustrated by a downward shift in the Consumption Function and an upward shift in the Savings Function remember that paying off debt is the same thing as increasing savings.
The opposite is also true. At low levels of debt people will consume more and save less.
You can likely think of other factors that are unrelated to income that could shift the Consumption and Savings Functions. In general, anything that influences consumption or savings that is NOT disposable income will shift the Functions upward or downward.
Any change in disposable income will move you along the Functions. Return to the course in I-Learn and complete the activity that corresponds with this material. The Interest Rate — Investment Relationship The second component of aggregate expenditures that plays a significant role in our economy is Investment. Remember from our lesson on National Income Accounting that investment only occurs when real capital is created. Investment is such an important part of our economy because it affects both short-run aggregate demand and long-run economic growth.
The dollars spent on the investment have the immediate impact of increasing spending in the current time period. But because of the nature of investment, it has a long-term impact on the economy as well.
If a company buys a new machine, that machine is going to operate, continue to produce, and will have an impact on the productive capacity of the economy for years to come. This is in contrast to consumption purchases that do not have the same impact.
If you buy and eat an apple today, that apple does not continue to provide consumption benefits into the future. Before the investment takes place, firms only know their expected rate of return.
Therefore, investment almost always involves some risk. It's hard to image, but let's say there isn't. There will still be consumption. Maybe people can do it by digging into their savings. They're essentially using resources that they've already accumulated in some way. Let's say that base level of consumption, let's call that It could be billions of dollars or gold coins or clamshells or whatever the unit of measuring economic activity is in our economy.
That's our base level of consumption. I'm just picking these numbers somewhat arbitrarily. Let's say if there's some above and beyond the base level, they're going to spend 0. Actually, to be a little bit more particular, I'll write not just income, I'll write disposable income.
I'll want to do that in a different color. I make the distinction, just to clarify our model, between income and disposable income because all of the aggregate income in an economy does not end up in consumers' pockets.
Just for a simplification, you might say, "Yeah, some of it ends up in firms' pockets," but the firms, at the end of the day, are owned by individuals, so it can end up in individuals' or consumers' pockets. But some of it goes off to the government. When you think about income, and if you spend any time looking at your pay stub this will become familiar to you, you have your income but you don't end up with all of that in your checking account or your pocket or your savings account.
Relationship between Disposable Income and Consumption
A good fraction of that is taken out for taxes. What you have left over when you subtract taxes out of income, that is your disposable income.
That's why I write this here because that's actually a more reasonable thing to say. They obviously can't spend a fraction of stuff that they don't have, the stuff that's taken out for taxes.
Just to visualize this, we can draw it. This will be a line. This might ring a bell from your early algebra days. Just the variables are different. Instead of a y, we have a c, but that's still the dependent variable. It's a function of disposable income.
In algebra you'll often call this the independent variable. The most typical variable is x. It's really the same idea over here.
Let me draw this a little bit neater. We can graph this, what's essentially going to be a line. It doesn't have to be a line. We just constructed a consumption function that happens to be a line. This is consumption right over here in the vertical axis.
Relationship between Disposable Income and Consumption
That could be in billions of dollars or clamshells or whatever else. Then right over here we have disposable income. If there is zero disposable income, maybe I'll draw a little table over here.
This is I'll call it disposable income and this is consumption. If there's zero disposable income, then this whole term right over here is 0. Then you have billion dollars, or whatever our units are, of base consumption.