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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.

Krugman and Wells 5th edition

3 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?

  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.


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