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Revision: Theory of Income and Employment >> Consumption Function (Propensity to Consume) Economics ISC (Commerce) Class 12 CISCE

Definitions [4]

Definitions: Consumption function

"The consumption function shows what changes can be expressed in the consumption from given changes in income." — Hansen
"Consumption function is nothing more than a statement of the relation between consumption, expenditure and income." — R.G. Lipsey
"It is a functional relationship indicating how consumption varies when income varies." — Dillard
"Consumption function may be defined as a schedule showing amounts that will be spent for consumer goods and services at different income levels." — Peterson

Definition: Average Propensity to Consume

"The average propensity to consume is the ratio of consumption to income \[\left(\frac{\mathrm{C}}{\mathrm{Y}}\right)\] at a specific level of income. It is the proportion of a given income that is spent for consumption purposes." — Peterson

Definition: Marginal Propensity to Consume

"By MPC we mean consumption expenditure that is induced by a change in income." — Peterson

Definition: Psychological Law of Consumption

“The psychology of the community is such that when aggregate real income is increased, aggregate consumption is also increased, but not by so much as income.” — Keynes

Formulae [4]

Formula: Average Propensity to Consume

$\frac{Total\ Consumption\ (C)}{Total\ Income\ (Y)}$
Symbolically: \[\mathrm{APC}=\frac{C}{Y}\]

Where:

$C$ = total consumption expenditure
$Y$ = total income

Formula: Marginal Propensity to Consume

Symbolically, \[MPC=\frac{\Delta C}{\Delta Y}\]

where ΔC = change in consumption and ΔY = change in income.

Formula: Average propensity to save

\[\mathrm{APS}=\frac{S}{Y}\]

Where:

$S$ = total saving
$Y$ = total income

Formula: Marginal propensity to save

\[\mathrm{MPS}=\frac{\Delta S}{\Delta Y}\]

Where:

$Δ S$ = change in saving
$Δ Y$ = change in income

Key Points

Key Points: Kinds or Technical Attributes of Propensity to Consume > Marginal Propensity to Consume

MPC shows what fraction of extra income is spent on consumption.
Usual range at this level: .
As income rises, MPC generally falls (people save a larger part of extra income).
MPC is higher for poor households, lower for rich households.
APC = C/Y, MPC = ΔC/ΔY; in the short run APC > MPC, in the long run APC tends to move closer to MPC.
Each extra rupee is either consumed or saved, so MPC + MPS = 1.

Key Points: Determinants of Propensity to Consume

Subjective factors: Psychological motives like miserliness, foresight, desire for wealth, security, liquidity preference, and business motives affect consumption habits.
Objective factors: External factors such as income level, income distribution, wages, interest rate, taxes, expectations, and wealth influence consumption.
Higher income equality, wage rise, windfall gains, and new products increase propensity to consume.
Higher savings motive, durable goods ownership, and price rise reduce propensity to consume.

Key Points: Psychological Law of Propensity to Consume

Consumption increases when income increases, but less than income.
Part of the extra income is saved.
MPC < 1 (Marginal Propensity to Consume is less than one).
Formula: ΔY = ΔC + ΔS
Break-even point: Income = Consumption (Saving = 0).
Higher income → higher savings.
Investment and government action may be needed to maintain demand.

Key Points: Measures to Raise Propensity to Consume

Redistribution of income in favour of the poor increases consumption and employment.
Social security measures reduce insecurity and encourage spending.
Easy credit facilities promote consumption of durable goods.
Higher wages and urbanisation raise purchasing power and demand.
Advertisements, demonstration effect, population growth, and better transport increase consumption habits.

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