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Unit 5: Consumption Function

Notes
The proportion of occasional coffee drinkers has increased in the last few years in the
non-south regions. The board is keen on exploiting this potential of non-south states. Tea
consumption is growing by 3% every year. "It is more of a common man's drink and used
in 90% of the households in the country," said Sujit Patra, Joint Secretary of Indian Tea
Association.
The higher consumption of coffee and tea is happening at a time when India is fast emerging
as a major market for soft drink and fruit juices. "India is a focus market for the Coca-Cola
company. The India business has now been growing for the last 19 quarters," said the
official spokesmen of the company.

Source: www.indiacoffee.org
Savings function can be derived inserting equation (2) into equation (1) and rearranging it so
that
Y = C+S

S = Y-C
= Y-(a+bY)
= Y-a-bY
S = -a+(1-b).Y {0<(1-b)<1}

Where, S and Y represent real saving and real income, respectively.
The parameter (1-b) referred to as the "marginal propensity to save" or MPS is the slope of the
saving function. If Y denotes change in income and S denotes change in saving associated with
the change in income, (1-b), MPS = S/ Y is (1-b) = S/ Y and its value ranges between 0 and 1.

Example: If the marginal propensity to consume is 0.8, the marginal propensity to
save is 0.2. This means that a 100 rise in income leads to 20 rise in saving; obviously,
MPC + MPS = 1.
Two other important concepts used by Keynes to explain the income-consumption and income-
saving relationships are the Average Propensity to Consume (APC) and the average propensity
to save (APS). The average propensity to consume (APC) is the ratio of consumption to income,
i.e.,

S
While the APS is the ratio of savings to income, i.e., APS =
Y
The APC tells us the proportion of each income level that a household will spend on consumption.
Similarly, the APS tells us the proportion of each income level that the household will save, i.e.,
not spend on consumption.

!
Caution Note that as income rises, the APC decreases while the APS increases.

Note also that APC and APS add up to 1, i.e., APC + APS = 1

Task Given C= 1200+ 0.8 Yd, where Yd= Y-T and T=100, find MPC.

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