Consumption and savings relationship tips

Consumption Function of Money: Meaning and Relationship with Income | Micro Economics

consumption and savings relationship tips

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Well, let me not switch the order, times the tax rate, not just the aggregate total tax value but the actual tax rate times aggregate income. That's those 2 terms there and then we're just left with the autonomous consumption. So, plus the autonomous consumption. Over here, we have a common factor. We can factor out the c1 and the Y, or essentially the marginal propensity to consume and the aggregate income.

consumption and savings relationship tips

This is just algebraic manipulation right over here. We get aggregate consumption is equal to, let's see, we could write this c1 1 - t Y. You can multiply this out to verify. If you multiply it all out then the 1st term is c1 1 Y is this right over here and c1 -t Y is this term right over here.

Then you're left with your autonomous consumption. This actually makes a lot of sense because when you write it like this, when you write it like this you could look at this term right over here. What is this term right over here? This whole term right over here is essentially disposable income. Disposable income right over here.

We could actually, if we wanted to write this as some other variable we could just put that variable right over there and say it's disposable income and then it actually becomes a very simple thing to graph.

We could graph this 2 different ways. If we wanted to write a function of aggregate income we would graph it like this. Now, when we express it this way, taxes as a function of aggregate income now our vertical intercept.

Consumption function basics

This is aggregate consumption. Our vertical intercept is this term right over here. That is C [not] and our slope is all of this business. The slope of our line is going to be C1 1 - t and this right over here, the independent variable is aggregate income.

The Relationship between Saving and Investment (Explained With Diagram)

Another option, we could set some other variable to what we could say disposable income. It's essentially equal to this business right over there.

This actually takes us back to the basics.

consumption and savings relationship tips

This takes us back to our very original situation here where we had some autonomous consumption plus our marginal propensity to consume times disposable income. If we wanted to plot it this way as a function of disposable income, not aggregate income then it would look like this. This is consumption, and now this is an aggregate income, this is disposable income which is the same thing as 1 - t Y.

Now, still our vertical intercept is C [not] and our line slope is the marginal propensity to consume. This is C1 just like that. The second sense in which saving and investment words are used is that in a certain year how much saving or how much investment people of the country desire or intend to do.

They are also called ex-ante saving and ex-ante investment. Thus, he used the word saving and investment in the ex-post or actual sense and proved the equality between saving and investment in the following way: Income of a country is earned in two ways: That is, national income of a country is composed of the value of consumer goods and services and the value of capital goods. This can be expressed in the form of the following equation: The above equation represents the production or earning side of the national income.

The second aspect of national income is the expenditure side. The total national income can be fully consumed but generally it does not happen so.

Consumption function basics (video) | Khan Academy

In actual practice, a part of the total income is spent on consumption and the remaining part is saved. From this we get the following equation: In the above two equations i and ii it is clear that national income is equal to the sum of consumption and investment and also equal to the sum of consumption and saving.

From this it follows that: In equation i investment is that part of national income which is obtained from the production of goods other than those consumed and equation ii saving is that part of national income which is not spent on consumption. Hence the actual or ex-post sense, saving and investment by definition are equal.

It is worth mentioning that in macroeconomics, saving and investment do not refer to the saving and investment by an individual; they refer to the saving and investment of the whole community or economy. Saving and investment by an individual can differ but in the ex-post sense, the saving of the whole country must always be equal to the investment. Now the question arises, why ex-post saving and ex-post investment are always equal.

For instance, when more investment is undertaken by the entrepreneurs how actual saving becomes equal to this larger investment and if the saving falls how investment will become equal to smaller savings. In this connection it is worth mentioning that modern economists, as did Keynes, include the addition to the inventories of consumer goods in investment.

consumption and savings relationship tips

Now, when saving increases, it implies that consumption will be less. The decline in consumption would result in the addition to the inventories of consumer goods with the shopkeepers and manufacturers, which were not planned or intended by them.

The Relationship between Saving and Investment (Explained With Diagram)

This addition to inventories, though unintended, will raise the level of actual investment. Thus unintended increase in inventories will raise the level of investment and in this way investment will increase to become equal to the greater saving. On the other hand, if in any year saving declines, it will result in the unplanned decline in the inventories of consumer goods with the traders and manufacturers.

This unintended decline in inventories will mean the fall in actual investment. In this way, investment will decline to become equal to the lower savings. Ex-ante saving and Ex-ante Investment are Equal only in Equilibrium: As said above, in the desired, planned or ex-ante sense, saving and investment can differ. In fact planned or ex-ante saving and investment are generally not equal to each other.

consumption and savings relationship tips

This is due to the fact that the persons or classes who save are different from those who invest. Savings are done by general public for various objectives and purposes.

  • The consumption function

On the other hand, investment is made by the entrepreneurial class in the community and is generally governed by marginal efficiency of capital on the one hand and rate of interest on the other hand.

Therefore, savings and investment in planned or ex-ante sense generally differ from each other. But through the mechanism of change in the income level, there is tendency for ex-ante saving and ex-ante investment to become equal.

When in a year planned investment is larger than planned saving, the level of income rises. At a higher level of income, more is saved and therefore intended saving becomes equal to intended investment. On the other hand, when planned saving is greater than planned investment in a period, the level of income will fall.

At a lower level of income, less will be saved and therefore planned saving will become equal to planned investment. We thus see that planned or ex-ante saving and planned or ex-ante investment are brought to equality through changes in the level of income. That the planned or intended saving is equal to intended investment only at the equilibrium level of income can be easily understood from Fig.

In this figure, national income is measured along the X-axis while saving and investment are measured along the Y-axis.