Consumption Function

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 = c + bY
Consumption-Function-Formula

Examples

Let us deal with some examples to understand this concept in detail

You can download this Consumption Function Formula Excel Template here – Consumption Function Formula Excel Template

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:

Consumption Function Example 1

By applying the formula

Consumption Function Example 1-1
  • Total Consumption (C) = 200 + 0.5 * 1000

Total Consumption (C) will be:-

Consumption Function Example 1-2
  • 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
C = c+bY
  • 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.

Recommended Articles

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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