Consumption Function

The amount of money spent by the people on the purchase of goods and services in order to satisfy their wants directly is called consumption expenditure. 

Consumption function or propensity to consume shows the relationship between total desired consumption spending by the households and the factors that determine it. The factors that can affect consumption of a person are income, rate of interest, wealth, liquid assets, future expectation about income, consumer credit, distribution of income, etc.

However among all the factors mentioned above Income is considered to be a major factor of propensity to consume.

Keynesian theory of consumption function, therefore, shows the functional relationship between the desired consumption expenditure and income.

Propensity to consume has two aspect:

1) Average propensity to consume

2) Marginal propensity to consume

Average Propensity to consume

The average propensity to consume is the ratio of consumption expenditure to any particular level of income.

Average Propensity to consume = Consumption / Income

APC = C / Y

For example : If income (Y), is Rs. 100 crore and consumption (C) is Rs. 80crore, then

APC = C / Y

APC = 80 / 100 = 0.8 or 80 %

This indicates that 80 per cent of the income is spent by way of consumption expenditure in the economy.

Marginal Propensity to consume

The marginal propensity to consume is the ratio of change in consumption expenditure to a change income.

Marginal Propensity to consume = Change in Consumption / Change in Income

MPC = ∆C  /  ∆Y

For example: If income (Y), increases from Rs. 1000 crore to Rs. 1200 crore and consumption expenditure increases from Rs. 800 crore to Rs. 900 crore, it means that change in income by Rs. 200 crore has caused a change in consumption by Rs. 100 crore.

MPC = ∆C  /  ∆Y

MPC = 900 - 800  /  1200 – 1000

          = 100 / 200

 = 0.5

Properties of Propensity to Consume 

There are three basic properties of Keynesian consumption Function

1) The first property of consumption function is that it directly depends on income, it increases as income increases.

Countries with higher income typically have higher level of consumption.

C = f (Y)

2) The second property is that, there is always some minimum level of C (consumption) irrespective of level of Y (income) . Increase in C tends to lag behind the increase in Y, because, after certain level of Y is reached, people start saving a part of Y.

To the extent when consumption increases with increase in income

 MPC i.e. (c)

C > 0

To the extent when consumption increases is less than the increase in income

 MPC i.e. (c)

C < 1

So MPC (c) ranges from zero and 1

 0 < c < 1

3) The third property is that the proportion of income consumed declines as income increases, means APC (average propensity to consume) decreases with increase in income.

As explained in the below table. As the income is increasing the proportion of income used in consumption is falling as indicated by the falling APC.

Y(Rs)	C (Rs)	APC = C / Y
60 80 100 120	45 50 55 60	0.75 0.62 0.55 0.50