Lesson 17 :Consumption

Video Lesson:

Competency (MLC)

Dear learners,

By the end of this lesson, you will be able to:

• Define consumption and its importance in economic contexts.
• Discuss the different properties of a consumption function.
• Compute and interpret average and marginal propensity to consume.
• Understand the role of consumption in economic growth and stability.

Brainstorming Questions

• How does disposable income influence consumption patterns?
• What factors determine the average propensity to consume (APC)?
• How does the marginal propensity to consume (MPC) affect saving behavior?
• Why is understanding consumption crucial for predicting economic fluctuations?

Key Terms

17.1 Consumption

Consumption is a fundamental economic concept that explores how households allocate their income between spending and saving. It plays a crucial role in determining aggregate demand and economic stability.

17.1.1 Properties of Consumption Function

The consumption function illustrates how consumption varies with disposable income. John Maynard Keynes introduced the concept, emphasizing a positive relationship between income and consumption.

$$\begin{gathered} \text{It can be expressed as:} \\ C=C_0+c\cdot Y_d \\ \text{Where:} \\ C:\text{Consumption expenditure} \\ {C}_0:\text{Autonomous consumption (independent of income)} \\ c:\text{Marginal propensity to consume (0 < c < 1)} \\ {Y}_d:\text{Disposable income} \end{gathered}$$

17.1.2 Average and Marginal Propensity to Consume

Average Propensity to Consume (APC):

• Ratio of total consumption to disposable income:

$$\begin{gathered} \text{APC}=\frac{C}{Y_d} \\ \text{Example:} \\ \text{If income is}4000\text{ETB and consumption is}3000\text{ETB,} \\ \text{APC}=\frac{3000}{4000}=0.75\text{.} \end{gathered}$$

Marginal Propensity to Consume (MPC):

• Change in consumption due to a change in disposable income:

$\text{MPC}=\frac{\Delta C}{\Delta Y_d}$

$$\begin{gathered} \text{Example:} \\ \text{If income increases from}1000\text{ETB to}2000\text{ETB,} \\ \text{and consumption increases from}800\text{ETB to}1400\text{ETB,} \\ \text{MPC}=\frac{(1400-800)}{(2000-1000)}=0.6\text{.} \end{gathered}$$

17.1.3 Role of Consumption

Consumption expenditure contributes significantly to GDP, reflecting economic health. Factors influencing consumption include income levels, distribution, taxes, expectations, interest rates, and wealth.

17.1.4 Determinants of Consumption Expenditure

• Income: Primary determinant affecting consumption levels.
• Distribution of Income: Poorer households tend to have higher APC.
• Taxes: Higher taxes reduce disposable income and consumption.
• Expectations: Future income and price expectations influence current consumption.
• Interest Rates: Higher rates encourage saving over consumption.

17.1.5 Consumption Function and Economic Analysis

The consumption function’s shape and slope (MPC) influence economic predictions. A steeper function indicates higher MPC, reflecting greater consumption responsiveness to income changes.