Consumption, Income, and Saving

 “Consumption, Income, and Saving” contains an example of a consumption function where autonomous consumption equals 10,000 and the marginal propensity to consume equals 0.8. If the household earns no income at all (disposable income = $0), it still spends $10,000 on consumption. In this case, savings equal −$10,000. This means the household is either drawing on existing wealth (accumulated savings from the past) or borrowing against income expected in the future. The marginal propensity to consume tells us how the household divides additional income between consumption and saving. In our example, the household spends 80 percent of any additional income and saves 20 percent. Table 12.3 Consumption, Income, and Saving

Disposable Income ($)

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Consumption ($)

Saving ($)

0 10,000 -10,000

10,000 18,000 -8,000

20,000 26,000 -6,000

30,000 34,000 -4,000

40,000 42,000 -2,000

50,000 50,000 0

60,000 58,000 2,000

70,000 66,000 4,000

80,000 74,000 6,000

90,000 82,000 8,000

100,000 90,000 10,000

For example, when income is equal to $20,000, consumption can be calculated as follows: consumption = $10,000 + 0.8 × $20,000 = $10,000 + 0.8 × $20,000 = $26,000. The household is still dissaving but now only by $6,000. Table 12.3 “Consumption, Income, and Saving” also shows that when income equals $50,000, consumption and income are equal, so savings are exactly zero. At income levels above $50,000, the household has positive savings. Figure 12.6 “Consumption, Saving, and Income” shows the relationship between consumption and income graphically. We also graph the savings function in Figure 12.6 “Consumption, Saving, and Income”. The savings function has a negative intercept because when income is zero, the household will dissave. The savings function has a positive slope because the marginal propensity to save is positive. Figure 12.6 Consumption, Saving, and Income

The graph shows the relationship between consumption and disposable income, where autonomous consumption is $10,000 and the marginal propensity to consume is 0.8. When disposable income is below $50,000, savings are negative, whereas at income levels above $50,000, savings are positive. As well as the marginal propensity to consume and the marginal propensity to save, we can examine the average propensity to consume, which measures how much income goes to consumption on average. It is calculated as follows:

average propensity to consume = consumption disposable income .

When disposable income increases, consumption increases but by a smaller amount. This means that when disposable income increases, people consume a smaller fraction of their income: the average propensity to consume decreases. [3] Meanwhile, the ratio of saving to disposable income is called the savings rate.

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