What is the Consumption Function?
The consumption function is an economic formula that directly connects total consumption and gross national income. The function introduced by British economist John Maynard Keynes indicates the relationship between income and expenditure and the proportion of income spent on goods.
Explanation
- It indicates that consumer spending is determined by the amount of income and the rate of increase or decrease of income. This concept, in the long run, is not stable because the income changes and consumption pattern changes.
- Here this function to be assumed as stable and expenditures determined the level of income. For valid concept long run it has to stable to reach equilibrium.
Consumption Function Formula
Below is the equation of consumption function.
- C – Total Consumption
- c – Autonomous Consumption (minimum consumption for survival when income is zero).
Autonomous consumption is not influenced by income – Here we have to understand that consumption can never be zero and if income becomes zero there is minimum consumption which never is nullified. Such consumption is called autonomous consumption. If income is low there is a minimum level of expenditure which is higher than the income. In such a case, consumption has to be maintained irrespective of the level of income. The minimum level of consumption is known as autonomous consumption. - Induced consumption (bY) (influenced by income) – bY; b is the marginal propensity to consumeMarginal Propensity To ConsumeMarginal Propensity to Consume refers to the increase in consumption owing to the increment in disposable income. It is determined as the ratio of change in consumption (ΔC) to change in disposable income (ΔI). read more (which means consumption level increased for every rupee increase in the income). Induced consumption influenced by income. Y clearly indicates i.e income.
- Break-even Point – When consumption expenditure reaches the income if there is no concept of saving it is called the break-even pointBreak-even PointBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost.read more stage.
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For eg:
Source: Consumption Function (wallstreetmojo.com)
Examples
Let us deal with some examples to understand this concept in detail
Calculate the consumption level Y=Rs.1000 crores if consumption function is C=200+0.5y?
Solution:
Use the below data for calculation of total consumption:
| Particulars | Value |
|---|---|
| Income (Y) | 1000 |
| Marginal Propensity (b) | 0.5 |
| Autonomous Consumption (c) | 200 |
By applying the formula
- Total Consumption (C) = 200 + 0.5 * 1000
Total Consumption (C) will be:-
- Total Consumption (C) = 700 Crores.
Consumption Function Calculator
You can use this calculator.
| c | |
| b | |
| Y | |
| Consumption Function Formula | |
| Consumption Function Formula= c + bY |
| 0 + 0 * 0 = 0 |
Relevance and Uses
- Consumption function equation describes
- If the value of (By ) is higher than the value of the total consumption will definitely increase. It clearly says that if income increases expenditure also increases. We have to consider that the income increase rate is more than the expenditure rate of increase. People having high incomes will have a lower average propensity to spend.
- Real consumption expenditure is a stable function of real income.
- The utility is adopted by consumption.
- Direct satisfaction of human needs has to appear by consumption.
- Consumption is nothing but a form of good change.
- Consumption is a direct function of income. Its functional relationship consumption varies as income varies.
- It allows an overview of the business expenditures in the total financial year.
- It helps in the prediction of future expenditures usually due to a thorough study of previous expenditures.
- Consumption is a function related to income and wealth.
- Consumption is the largest component of the nation’s gross domestic product which plays a prominent role in the economy of the nation.
- Consumption function depends on the rates of interest, but it’s not a significant factor.
- By this theory, it is clear that low consumption results in the high saving of the economy. The saving amount increases with an increase in income as consumption function solely increases with income.
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This has been a guide to the consumption function and its definition. Here we discuss how to calculate consumption function using its formula along with practical examples, calculator, and downloadable excel template. You can learn more about financial analysis from the following articles –
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