Video Lesson

Lesson Objectives

Dear Students, By the end of this lesson, you will be able to:

1. Define consumption and its importance in economic contexts.Discuss the different properties of a consumption function.Compute and interpret average and marginal propensity to consume.
2. Understand the role of consumption in economic growth and stability.
3. Consumption Function: Mathematical representation showing the relationship between income and consumption.

Brainstorming Questions

1. How does disposable income influence consumption patterns?
2. What factors determine the average propensity to consume (APC)?
3. How does the marginal propensity to consume (MPC) affect saving behavior?
4. Why is understanding consumption crucial for predicting economic fluctuations?

Key Terms and Concepts

1. Marginal Propensity to Consume (MPC): Rate of change in consumption relative to disposable income.

4.1 Consumption

Consumption is a fundamental economic concept that explores how households allocate their income between spending and saving. It plays a crucial role in determining aggregate demand and economic stability.

4.1.1 Properties of Consumption Function

The consumption function illustrates how consumption varies with disposable income. John Maynard Keynes introduced the concept, emphasizing a positive relationship between income and consumption. It can be expressed as: C=C0+c⋅YdC = C_0 + c \cdot Y_dC=C0​+c⋅Yd​ Where:

• CCC: Consumption expenditure
  • C0C_0C0​: Autonomous consumption (independent of income)
  • ccc: Marginal propensity to consume (0 < c < 1)
  • YdY_dYd​: Disposable income

4.1.2 Average and Marginal Propensity to Consume

• Average Propensity to Consume (APC): Ratio of total consumption to disposable income. APC=CYdAPC = \frac{C}{Y_d}APC=Yd​C​ Example: If income is 4000 ETB and consumption is 3000 ETB, APC = 3000 / 4000 = 0.75.
  • Marginal Propensity to Consume (MPC): Change in consumption due to a change in disposable income. MPC=ΔCΔYdMPC = \frac{\Delta C}{\Delta Y_d}MPC=ΔYd​ΔC​ Example: If income increases from 1000 ETB to 2000 ETB, and consumption increases from 800 ETB to 1400 ETB, MPC = (1400 – 800) / (2000 – 1000) = 0.6.

4.1.3 Role of Consumption in Economic Growth

Consumption expenditure contributes significantly to GDP, reflecting economic health. Factors influencing consumption include income levels, distribution, taxes, expectations, interest rates, and wealth.

4.1.4 Determinants of Consumption Expenditure

• Income: Primary determinant affecting consumption levels.
  • Distribution of Income: Poorer households tend to have higher APC.
  • Taxes: Higher taxes reduce disposable income and consumption.
  • Expectations: Future income and price expectations influence current consumption.
  • Interest Rates: Higher rates encourage saving over consumption.
  • Wealth: Higher wealth levels increase consumption.

4.1.5 Consumption Function and Economic Analysis

The consumption function’s shape and slope (MPC) influence economic predictions. A steeper function indicates higher MPC, reflecting greater consumption responsiveness to income changes.