Consumption, Saving, Investment, and the Multiplier ❮ 938.1 Consumption and Saving
Main Topics: Consumption and Saving Functions, Marginal Propensity to Consume and Save,
Changes in Consumption and Saving
The circular flow model illustrates the importance of consumption in the production of
goods and the employment of resources. A better understanding of consumption allows us
to build a model of the macroeconomy and see the role of policy in affecting macroeco-
nomic indicators like GDP, employment, and inflation.Consumption and Saving Functions
Though not the only factor, the most important element affecting consumption (and sav-
ings) is disposable income. Disposable income (DI) is what consumers have left over to
spend or save once they have paid out their net taxes.
DI = Gross income - Net taxes
where Net taxes = (Taxes paid - Transfers received).
With no government transfers or taxation, DI = C + S. Though not all consumers save
part of their income, typical consumers spend the majority of their disposable income and
save whatever is left over. To see the relationship between disposable income and consump-
tion, we create a consumption function.Consumption and Saving Schedules
The consumption and saving schedules are the direct relationships between disposable
income and consumption and savings. As DI increases for a typical household, C and S
both increase. Table 8.1 provides an example.Table 8.1
DISPOSABLE INCOME (DI) CONSUMPTION (C) SAVINGS (S)
0 40 - 40
100 120 - 20
200 200 0
300 280 20
400 360 40
500 440 60Consumption
Even with zero disposable income, households still consume as they liquidate wealth (sell
assets), spend some savings, or borrow (dissavings). For every additional $100 of disposable
income, consumers increase their spending by $80 and increase saving by $20. We can
convert the above consumption schedule to a linear equation or consumption function:
C = 40 + .80(DI)
The constant $40 is referred to as autonomous consumption because it does not
change as DI changes. The slope of the consumption function is .80. This function is
plotted in Figure 8.1.