Page 105 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 9. ......................also represents the slope of the consumption function.
10. In equation, C= a + b.Y, a represents the level of consumption that would be there even
when the income is ......................

11. If MPC is 0.6, MPS would be ......................
12. ...................... represents the proportion of each income level that a household will spend
on consumption.

13. The relative income hypothesis was given by ......................
14. If MPS = 0.3, it means that a 100 rise in disposable income leads to ...................... rise in
consumption.

5.3 Factors Determining Propensity to Consume

The amounts of consumption depend solely upon the level of disposable income. Many other
factors help determine how any given level of disposable income will be divided between
consumption and saving. Moreover, changes in these other factors can shift the consumption
function up or down. This can lead to more less consumption at each level of income. Some of
the more important of these factors are enumerated below.
The Stock of Wealth: Wealth has been regarded as the most important determinant of
consumption. Other things being constant, a wealthy community might be expected to
consume a larger part of its income than a group with the same income but less wealth.
The larger the wealth possessed by a person, the lower would be the desire to add to future
wealth, by reducing consumption spending. Consumption, therefore, will be higher wealth.
Windfall capital gains losses also have an impact on aggregate consumption.
Expectations: The consumption of a person is also influenced by expectations regarding
future movements in income and prices. For example, when future levels of income are
expected to be higher than present levels, the consumer community is likely to consume
more out of its current disposable income.
Taxation Policy: Taxation measures of the government may influence the average
propensity to consume (APC), i.e., C/YD and bring about shifts in consumption function.
An increase in direct taxes will reduce disposable income at all levels of income and the
reverse may occur when taxes are reduced. Similarly, a tax structure based on progressive
taxation leads to increase in the level of consumption expenditure.

Distribution of Total Household Income by Size of Household Income: For example, total
saving out of a given level of total household income is likely to be higher if a greater part
of the total income accrues to high income classes, rather than to low income groups.
Age Composition of the Population: Both elderly and young families have higher
propensities to consume than families in their middle years. A shift in age composition
could shift consumption and saving functions.

Task Discuss what would happen to consumption function if,
(a) Consumer experience an increase in wealth
(b) Taxes are increased
(c) Consumer expect prices to rise rapidly in future
(d) Interest rates fall

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