Consumption function: Difference between revisions

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where <math>a</math> is the [[autonomous consumption]] that is independent of disposable income; in other words, consumption when disposable income is zero. The term <math>b \cdot Y_{d}</math> is the [[induced consumption]] that is influenced by the economy's income level <math>Y_{d}</math>. The parameter <math>b</math> is known as the [[marginal propensity to consume]], i.e. the increase in consumption due to an incremental increase in disposable income, since <math> \partial C / \partial Y_{d} = b</math>. Geometrically, <math>b</math> is the [[slope]] of the consumption function.  
where <math>a</math> is the [[autonomous consumption]] that is independent of disposable income; in other words, consumption when disposable income is zero. The term <math>b \cdot Y_{d}</math> is the [[induced consumption]] that is influenced by the economy's income level <math>Y_{d}</math>. The parameter <math>b</math> is known as the [[marginal propensity to consume]], i.e. the increase in consumption due to an incremental increase in disposable income, since <math> \partial C / \partial Y_{d} = b</math>. Geometrically, <math>b</math> is the [[slope]] of the consumption function.  


Keynes proposed this model to fit three [[Stylized fact|stylized facts]]:<ref>{{Cite book |last=Mankiw |first=N. Gregory |url=https://www.worldcat.org/oclc/1289514240 |title=Macroeconomics |date=2022 |isbn=978-1-319-26390-4 |edition=11 |location=New York |at=20-1 What Determines Consumer Spending? |oclc=1289514240}}</ref>
Keynes proposed this model to fit three [[Stylized fact|stylized facts]]:<ref>{{Cite book |last=Mankiw |first=N. Gregory |title=Macroeconomics |date=2022 |isbn=978-1-319-26390-4 |edition=11 |location=New York |at=20-1 What Determines Consumer Spending? |oclc=1289514240}}</ref>


* People typically spend a part, but not all of their income on consumption, and they save the rest. They typically do not borrow money to spend, or borrow money to save.<ref name=":0">{{cite book |last=Keynes |first=John M. |title=[[The General Theory of Employment, Interest and Money]] |publisher=Harcourt Brace Jovanovich |year=1936 |location=New York |at=Section 3.8.2 |quote=There are not many people who will alter their way of living because the rate of interest has fallen from 5 to 4 per cent, if their aggregate income is the same as before... the short-period influence of the rate of interest on individual spending out of a given income is secondary and relatively unimportant, except, perhaps, where unusually large changes are in question.}}</ref> This fact is modelled by requiring <math>b \in (0,1)</math>.
* People typically spend a part, but not all of their income on consumption, and they save the rest. They typically do not borrow money to spend, or borrow money to save.<ref name=":0">{{cite book |last=Keynes |first=John M. |title=[[The General Theory of Employment, Interest and Money]] |publisher=Harcourt Brace Jovanovich |year=1936 |location=New York |at=Section 3.8.2 |quote=There are not many people who will alter their way of living because the rate of interest has fallen from 5 to 4 per cent, if their aggregate income is the same as before... the short-period influence of the rate of interest on individual spending out of a given income is secondary and relatively unimportant, except, perhaps, where unusually large changes are in question.}}</ref> This fact is modelled by requiring <math>b \in (0,1)</math>.
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{{Authority control}}
{{Authority control}}


[[Category:Consumption (macroeconomics)]]
[[Category:Consumption (economics)]]

Latest revision as of 21:18, 26 August 2025

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File:Consumption Function.png
Graphical representation of the consumption function, where a is autonomous consumption (affected by interest rates, consumer expectations, etc.), b is the marginal propensity to consume and Yd is disposable income

In economics, the consumption function describes a relationship between consumption and disposable income.[1][2] The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a government spending multiplier.[3]

Details

Its simplest form is the linear consumption function used frequently in simple Keynesian models:[4]

C=a+b⋅Yd

where a is the autonomous consumption that is independent of disposable income; in other words, consumption when disposable income is zero. The term b⋅Yd is the induced consumption that is influenced by the economy's income level Yd. The parameter b is known as the marginal propensity to consume, i.e. the increase in consumption due to an incremental increase in disposable income, since ∂C/∂Yd=b. Geometrically, b is the slope of the consumption function.

Keynes proposed this model to fit three stylized facts:[5]

  • People typically spend a part, but not all of their income on consumption, and they save the rest. They typically do not borrow money to spend, or borrow money to save.[6] This fact is modelled by requiring b∈(0,1).
  • People with higher income save a higher proportion of the income. This is modelled by CYd decreasing with Yd.
  • People, when deciding how much to save, are insensitive to the interest rate.[6]

By basing his model in how typical households decide how much to save and spend, Keynes was informally using a microfoundation approach to the macroeconomics of saving.[7]

Keynes also took note of the tendency for the marginal propensity to consume to decrease as income increases, i.e. ∂2C/∂Yd2<0.[8] If this assumption is to be used, it would result in a nonlinear consumption function with a diminishing slope. Further theories on the shape of the consumption function include James Duesenberry's (1949) relative consumption expenditure,[9] Franco Modigliani and Richard Brumberg's (1954) life-cycle hypothesis, and Milton Friedman's (1957) permanent income hypothesis.[10]

Some new theoretical works following Duesenberry's and based in behavioral economics suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviorally-based aggregate consumption function.[11]

See also

Notes

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  1. ↑ Algebraically, this means C=f(Yd) where f:ℝ+→ℝ+ is a function that maps levels of disposable income Yd—income after government intervention, such as taxes or transfer payments—into levels of consumption C.
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  7. ↑ Script error: No such module "Citation/CS1".
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  9. ↑ Script error: No such module "citation/CS1".
  10. ↑ Script error: No such module "citation/CS1".
  11. ↑ Script error: No such module "Citation/CS1".

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Further reading

  • Script error: No such module "citation/CS1". (Undergraduate level discussion of the subject.)
  • Script error: No such module "citation/CS1". (Graduate level discussion of the subject.)

External links

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