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Consumption Function

In macroeconomics consumer spending is measured by the household. Using this model, the most important determining factor of consumer spending is a family's disposable income. While salaries are typically how people report earnings, income after taxes and government transfers (disposable income) is the true measure of spending possibilities. The typical analysis of the relationship between a household's disposable income and its consumer spending is done via the consumption function, c= a + MPC x yd. In this equation c is consumer spending, yd is disposable income, MPC is the marginal propensity to consume, and a is household autonomous consumer spending (a constant).

From this graph we see the consumption function at work. The slope of the graph is the natural log of MPC, which stays relatively smooth over time. This is in line with the concept that over time our consumption stays constant. A point of note representing potential changes to our consumption is seen in 2008/2009 during the Great Recession. Because of this monumental event there was a decrease in many households' disposable income and therefore a decrease in consumer spending.

The aggregate consumption function shows the relationship between aggregate current disposable income and aggregate consumer spending. It has the same form as the household level consumption function, therefore its equation is also C = A+ MPC x YD, where A is the aggregate autonomous consumer spending (the amount of consumer spending when YD=0) and YD is the aggregate current disposable income.

As with any function, certain changes cause shifts in the aggregate consumption function. If something other than disposable income changes, which would simply cause a movement along the function, the function shifts. Two principle causes of this are changes in expected future disposal income and changes in aggregate wealth.

For example, an employee expecting a big promotion will typically increase their consumption due to this expectance of an increase in future displays income. This would cause an upward shift of the aggregate consumption  function. On the other hand, an employee expecting to be laid off from their job in the near future may decrease his or her consumption due to this expectance of decrease in future disposable income, causing a downward shift in the aggregate consumption function. An example of a change on aggregate wealth is having just paid off your mortgage; you have accumulated more wealth by owning your house and by having more disposable income to save and spend due to no longer having to pay that bill every month.

Sources:
Flat World Knowledge and Krugman and Wells 5th edition.

13 thoughts on “Consumption Function

  1. bernsteinl20

    Except for minor blips during recessions, the consumption is continuously growing. I'm wondering if this is completely a good thing? Does this show a lot of continuos inflation? Is this just the natural growth of the economy as the size of the American population grows?

    1. minsong20

      I was reading that part of what happens in the cycle of consumption is the periodic crash. The author said that because we live on an artificial standard of money, i.e. off the gold standard, and we use so much credit, we are postponing the inevitable crash and seeing consumption outstrip resources.

      1. ingramk20

        Do we know when we would expect to see a noticeable crash? Even the 2008-09 financial crisis only appears a small decline in consumption expenditures, which makes sense because individuals can only pare down consumption by so much (they'll always have to pay the mortgage, the car payment, food, etc). Based on what you've read how will this function look in the long run. What would a "correction" look like?

  2. dodsonm20

    I wonder if consumer spending impacts the economy even further. It makes sense for it to change in times of economic decline but I wonder if it has any other relationships with the economy. Another representation of the graph that may be useful is one with percent change from a year ago. This might show more insight into the short term change of consumer spending and not just the long term trend.

  3. samuelm20

    The curve representing the log of MPC seams almost too fitting with what we learned in the class and from the textbook. Do you think this is a result of fact that the measurements are over 50 years? Would the data look more different if it were looking at a smaller time period? I also feel like the 2008 dip looks too small, but this is probably construed because it is log data. I wonder what the original data looked like.

    1. mannm20

      I agree with your comment about the 2008 dip appearing too small in comparison with the rest of the data. I think an original graph might provide more information or better represent that recession. I am also curious about the example of an employee expecting either a big raise in pay or a layoff. Why might the consumption function shift based merely off of personal expectations especially when an increase in spending could be detrimental down the line without the change in salary?

  4. prochniaka20

    Along with Mariam and Molly, I was also surprised by how small the 2008 dip was in the graph. In other times of recessions, the dips were even smaller or did not seem to occur at all. I wonder why that is.

    1. skinnerf20

      I think that is the effect of the consumption function- it stays relatively constant over time. It took such an overarching recession to have a noticeable impact on the graph. We know the early 70s recession was a massive financial crisis, but even this period saw very little change to the consumption function.

  5. scottm20

    This was an interesting look at disposable income and its effect on the consumption function. As with others, I took notice of the dip from essentially July 2008 to June 2009. Upond further research, it appears the major factor in the dip was bad deflation that accompanies recessions. Bad deflation leads to widespread layoffs as struggling businesses are forced to cut payrolls, causing the workforce to decrease until economic production realigns with the reduced level of aggregate demand. Between July 2008 and July 2009, during the dip in personal consumption expenditures, the labor market lost 7 million jobs and GDP shrunk by more than $450 billion. The dip in 08-09 was most likely exasperated by bad deflation that spiraled out of control. (https://www.chase.com/news/082817-deflation-not-always-bad)

  6. dugganj20

    It is interesting to see the difference of consumer's incomes before and after taxes and government transfers are taken into account. Despite these deductions, the consumer spending graph shows to be strongly positive throughout time. I wonder when we will see the next dramatic dip in consumer spending, and how much it will affect the economy.

  7. faithepinho

    This is a thorough, thoughtful explanation of the consumption function. Now, how is this useful in other macroeconomic topics? How can we use the visual of an ever increasing consumption function to better understand GDP? Or investment?

  8. the prof

    It would be interesting to set this against various measures of savings – household, corporate.
    Of course in a growing economy C increases – more people, more per person real income.
    No particular reason to thing there will be a crash. That we aren't on the "gold standard" in fact is associated with a more stable economy - there's nothing special about gold, or sterling silver, or (the 18th century Japanese money I brought to class) commodities in a warehouse or cowry shells or cocoa beans (15th-16th century Mesoamerica). The flip side – the particulars of how "the" gold standard operated – led to bigger booms and busts, it amplified shocks. Good riddance.

  9. montjoyr20

    I interested in what differentiates the dip we see from the 2008 recession from any other recession we have seen over the past 40+ years. Is the severity of the great recession compared to other recessions the primary explanation for differences on the graph, or was their a factor unique to 2008 that helps explain the dramatic dip on the chart?

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