CONSUMPTION

USLT ECON 1
Prepared by: Zeneth O. Quilenderino
CONSUMPTION
Amount of money spent on goods and
services which yield direct satisfaction
Biggest of all the major components of
expenditure on output
Examples: buying food, paying the services of the doctor

Purchase of a bond which generates an income in the

future does not produce direct satisfaction. Thus, its
purchase is not considered as consumption.
Yd = C + S

That part of income which is not

consumed is called savings.
 Distribution of national income
Rate of interest
The desire to hold cash
FACTORS Price level
INFLUENCING
CONSUMPTION Population
Income
Taxes
Attitudes and values
 It is the functional relationship
between income and consumption.
CONSUMPTION
FUNCTION All other things constant, consumption
primarily depends on income. Any
change in consumption is due to change in
income in most cases.
 Average Propensity to Consume:
fraction of income spent on consumption
CONSUMPTION Marginal Propensity to Consume: ratio
FUNCTION of the increase in consumption to the
increase in income that caused it
Under short run consumption function, is it
possible for consumption to exceed income?
Yes. An individual can spend more than his income by
using his past savings or by borrowing.

In the long run, is it still possible?

No. Savings are already exhausted and loans have to be
paid. If not, then borrowers also exhaust their credit.
 The life-cycle model of consumption was developed by
economist Franco Modigliani who argued that
households form a view about their likely or expected
income over their life cycle, and then base their spending
decisions around this.
This helps to explain why people in well paid jobs in their
The Life- early twenties are prepared to borrow heavily to
finance current consumption (e.g. a new car, furnishings
Cycle for a property) because they expect to be able to repay
loans as their disposable income increases.
Model Similarly people reaching middle age often become
net savers because they are anticipating saving for their
retirement.
One of the results of the life-cycle model is that changes
in the age structure of the population can have big
effects on total consumer spending.
 This model of consumption is associated with the late US
economist Milton Friedman. He believed that people
base their spending decisions on expectations of
permanent income - the average income that people
The can earn over their lifetime.
Permanent A distinction is made between transitory income (e.g. a

Income windfall gain in income) and permanent income. Friedman

believed that changes in transitory income would not affect
Model spending and saving decisions. But that shifts in permanent
income would be important in shaping our spending levels.
According to the model, only changes in permanent
income have any long-term effect on consumption.
But transitory changes in spending power can lead to a
more volatile pattern for the propensity to consume.
 Corporate savings provide a cushion for
businesses during a recession. They can also be
used as finance for merger and takeover
activity.
Importance of Savings flow into financial institutions; deposits
saving for are used for lending out to businesses to
macro- finance investment. Banks need deposits as
economy capital from which they can lend and savings
flow into pension funds these can be
reinvested in stock markets.
Savings provide a source of household wealth
and a buffer against uncertain times.
 A higher level of domestic savings reduces the
dependence of the government and businesses
on foreign money when they are issuing new
debt (e.g. bonds).
Importance of Higher savings are needed to provide the flow
saving for of funds that might finance high quality capital
macro- investment which itself provides the
economy foundation for long run economic growth. The
low level of personal saving is seen as a
weakness of Philippine economy. It makes
Philippine growth less sustainable.
 Expenditure on new capital goods
Plays a vital role in the economy because it
creates more employment, production and
consumption
More investment means more national income
or gross national product
Most fickle component of expenditure which
causes economic fluctuations
 The decision to invest is based largely on
expected profits.

The difference of the good and bad side

INVESTMENT
of foreign investment lies in the
DECISIONS
competence, patriotism and
integrity of government economic
managers.
 Marginal efficiency of investment (MEI) or
returns of investment (ROI)
Interest rate

DETERMINANTS Factors affecting MEI:

OF INVESTMENT Population
Price level
Technology
Peace and order
Government policies
 When an individual buys goods and services, his
expenditure becomes the income of the owners/ sellers
of goods and services.
That part of income which was not spent is called
savings. Reasons for saving: future economic security,
emergency situations, business speculation, or future
Consumption, transactions
Savings, and Savings contribute to the economy if these are placed
Investment in banks and other financial institutions. They become
funds for investment.
It is more favorable economic condition when
investment exceeds savings.
If savings exceed investment, it contracts the
economy.
 Investment creates more income several times. This
MULTIPLIER multiplied effects of investment on income is called
AND MULTIPLIER EFFECT.
ACCELERATOR This is the ratio of the increase in income to the
increase in investment
 When there is an increasing consumption level, it
means good business environment. And this is what
investors like because they anticipate good profits.
MULTIPLIER Investment generates more jobs. This means more
AND income due to additional employment. When there are
more people employed, consumption consequently
ACCELERATOR increases because they have greater purchasing power.
This accelerates economic growth: more investments
which result to more incomes, and then more
consumption.
PARADOX OF
THRIFT
 The paradox of thrift is an important idea from Keynesian
economics.
Saving is regarded as positive for the economy, not least
because it provides the funds to finance the capital
investment needed to promote long-term growth.
But if many people start saving more at the same time,
the result is a reduction in consumer demand and an even
PARADOX OF deeper recession causing a fall in real incomes.
THRIFT What is rational and virtuous for an individual might be
damaging for the economy as a whole.
At an international level, when the global desire to save
exceeds the global willingness to invest the result is a
contraction in world aggregate demand and production,
a fall in incomes and employment, which eventually
brings savings back into balance with investment.
 Explain in 5 sentences why
consumption is NOT the engine
of our economy. Use your own
words and understanding. DO
QUESTION NOT pull out sentences from the
article.
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