Consumption Function In Economics

In economics, the consumption function describes a relationship between consumption and disposable income.[1] Algebraically, this means where is a functionthat maps levels of disposable income —income after government intervention, such as taxes or transfer payments—into levels of consumption . 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.[2] Its simplest form is the linear consumption function used frequently in simple Keynesian models:[3]

where is the autonomous consumption that is independent of disposable income; in other words, consumption when income is zero. The term is the induced consumption that is influenced

It is usually broken down into the demand for the following factors:

C for Consumption, I for Investment, G for Government Spending and NX for Net Exports. Some textbooks break it down into exports and imports but net exports is simply exports minus imports.

Initially we will only consider changes in consumption, making investment, government spending and net exports exogenous to our model which we designate by putting a horizontal bar over top of them.

Consumption Function

To begin we're going to look at how consumption is related to income. We're going to break down consumption into its separate components. Beginning with autonomous consumption. This is the base level of consumption. In this model, consumption cannot fall below autonomous consumption, regardless of what people are making as income. Next we have disposable income. This is the "after tax" income. Although "disposable income" is commonly used as the money you have remaining after you've paid your rent and bills, that's now what it means in economic terms. Disposable income is multiplied by the coefficient c, the "marginal propensity to consume". This tells us how much consumption increases for every $1 increase in income. The MPC coefficient can be between zero and

Consumption, the dependent variable, is on the Y-axis. Disposable income, the independent variable, is on the X-axis. The level of autonomous consumption determines the Y-intercept. As you recall, this is the level of consumption when disposable income is zero. Marginal propensity to consume determines the slope of this curve. As disposable income increases from left to right it is modified by the MPC. A high MPC of 0.9 would lead to a steep curve. A lower MPC would mean a more gradual slope.

Income

Now we're going to take a closer look at disposable income. This is an aggregate measure of all the income paid to households plus government transfers (such as welfare of social security) minus income taxes. As it's presented here, government transfers and taxes do not change relative to our dependent variable, income. Again, this is shown by the horizontal bar above the two exogenous variables.

Generally income taxes are some percentage of income. Although it's not that simple in practice, in this model we're going to think of taxes as flat rate, denoted by the lower case t. The coefficient could be any number between zero, meaning no tax, and one, meaning all income would be paid in taxes. This is then multiplied by