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Consumption Function - Essay Example

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Consumption function expresses the relationship between consumption and disposable income (income after tax). Symbolically, this functional relationship between consumption and disposable income is represented as C = f(Y), where C signifies consumption, Y depicts income, and f symbolizes the functional relationship between the two variables, consumption and income…
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Consumption Function
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Download file to see previous pages In technical language, consumption is a function of (determined by) income. This relationship between consumption and income is termed as 'consumption function' or 'propensity to consume'. Keynes (1936) believes this relationship to be 'a fairly stable function'. At an empirical level, consumption function portrays a schedule of various amount of consumption expenditure corresponding to different levels of income.
As can be seen in Table 1, when the consumer's income is $0, the consumer spends $60 either from his/her past savings. When the consumer's income is $100, the corresponding level of consumption is $150, which indicates that the consumer's income is inadequate to meet the expenditure. It is only when the consumer's income reaches $250 that the consumption equals income. Until this equilibrium point consumption exceeds income leading to negative saving, and beyond that point the consumer's income exceeds expenditure resulting in positive savings.
In Figure 1, income is measured on the X axis and expenditure on the Y axis. The unity line C= Y, which is basically a 450 line, presents a scenario that consumption corresponds to income at all levels of income. The C curve is a non-linear consumption function based on the assumption that consumption increases by a decreasing amount. Its upward slope to the right indicates that consumption is an increasing function of Income.
Types of consumption functions:
Depending on the consumption pattern of a consumer, the actual functional form of the equation can be linear with a constant slope or curvilinear with a changing slope.
1. A linear consumption function beginning from the origin can be written as C = bY where C = Consumption expenditure, Y = Income and 'b' represents the fraction of income which is spent on consumption, and it represents the slope of the consumption function.
2. A linear consumption function beginning at an intercept can be written as:
C = a + bY, where C represents consumption expenditure, Y is income, 'a' stands for the intercept and 'b' symbolizes the slope. The intercept 'a' measures the amount of consumption when income is zero. The value of intercept 'a' is positive, and it is conceptually referred to as 'autonomous consumption'. The term 'autonomous consumption' is used to explain the situation in which the consumer's consumption is unrelated to the level of income (Begg et al 1997). As presented in Table 1 as well as Figure 1, when consumer's income is zero, the consumption expenditure accounts for $60, which is described as 'autonomous consumption' since it is not related to the level of consumer's income.
3. A nonlinear consumption function beginning from the origin can be written as:
C = bYn, where n is a positive constant ...Download file to see next pagesRead More
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