(Remember the idea of a slope being the rise over the run? Go back to the graph of the consumption function and satisfy yourself that the rise is the change in Consumption and the run is the change in Income, and you will see that this definition of b is consistent with the definition of a slope.) In economics, “b” is a particularly important variable because it illustrates the concept of the Marginal Propensity to Consume (MPC), which will be discussed below. It is the change in consumption resulting from a change in income. If Income is measured in dollars, you might ask the question, “How much would your Consumption increase if your Income were increased by one dollar?” The slope, b, would provide the answer to that question. It represents the expected increase in Consumption that results from a one unit increase in Disposable Income. In the consumption function, b is called the slope. In any case, “a” is the amount of consumption when disposable income is zero and it is called “autonomous consumption,” or consumption that is independent of disposable income. In fact, some of you students may have no income, and yet you are still consuming because of borrowing or transfers of wealth from your parents or others to you.
In other words, what would your consumption be if your disposable income were zero? Can there be consumption without income? People do this all the time. The intercept is the value of C when Yd is equal to zero. Let’s explore their meanings in economics. In the above equation, “a” is the intercept of the line and b is the slope. To simplify our discussion, we will assume that Consumption is a linear function of Disposable Income, just as it was graphically shown above. Disposable income is that portion of your income that you have control over after you have paid your taxes. The Consumption Function shows the relationship between consumption and disposable income. The graph below demonstrates the relationship between consumption and savings: In economics we call this “dissavings.” Point E is called the breakeven point because it is the point where there are no savings but there are also no dissavings. How can savings be negative? If you thought of borrowing, you are right. At income levels to the right of point E (like Io), savings is positive because consumption is below income, and at income levels to the left of point E (like I'), savings is negative because consumption is above income. At that point, labeled E in our graph, savings is equal to zero. Notice the use of the 45˚ degree line to illustrate the point at which income is equal to consumption. Consider the graph below, which shows Consumption as a positive function of Income: If income goes up then consumption will go up and savings will go up. In this simple model, it is easy to see the relationship between income, consumption, and savings. In the simplest model we can consider, we will assume that people do one of two things with their income: they either consume it or they save it. Because government spending is determined by a political process and is not dependent on fundamental economic variables, we will focus in this lesson on an explanation of the determinants of consumption and investment. The components of aggregate expenditures in a closed economy are Consumption, Investment, and Government Spending. Thus, to calculate consumptio n at any level of income, multiply the income level by 0.8, for the marginal propensity to consume, and add $600, for the amount that would be consumed even if income was zero.Before developing the Keynesian Aggregate Expenditures model, we must understand the basic macroeconomic relationships that are the components of that model. Even if income were zero, people would have to consume something. We call the level of consumption when income is zero autonomous consumption, since it shows the amount of consumption independent of income. In this example, consumption would be $600 even if income were zero. Second, at low levels of income, consumption is greater than income. Thus, the slope of the consumption function is the MPC. For every increase in income, consumption increases by the MPC times that increase in income.
First, consumption expenditure increases as income does. There are a couple of features to observe. Both the table and figure illustrate a typical consumption function. The relationship between income and consumption, whether in tabular or graphical form is called the consumption function. The pattern of consumption shown in Table 1 is plotted in Figure 1.
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