Consumption Function

Consumption Function

• In our initial model, consumption is determined by the level of income. The relationship between C and Y is called the consumption function.

C = f( Y )

• The Keynesian Consumption Function is :

C = Co + MPC x Y

C = 100 + 0.9 Y

where Co is independent of Yand MPC = ˛C / ˛Y = the marginal propensity to consume.

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The Keynesian consumption function describes planned household spending.

The part of consumption that is independent of income, Co, can be sustained by drawing on past savings or borrowing.

The marginal propensity to consume, MPC, plays a key role in Keynesian macroeconomic equilibrium models.

There are many other theories of the consumption function. Milton Friedman, for example, argues that consumption is determined by peoples’ estimates of their “permanent” or long-term, average income. If this is true, consumption is much less sensitive to changes in the current level of income.