Class notes ECO 101 INTRODUCTION TO MACROECONOMICS

LECTURE III
CONSUMPTION, SAVINGS AND INVESTMENTS


Consumption Function
C α  βY

The function shows that consumption is an increasing function of income.
However, the marginal increase in consumption will be less than the marginal increase in
income. That is β 1.
The marginal increase in consumption resulting from an increase in income is called
marginal propensity to consume (MPC).
MPC is the change in consumption arising from a unit change in income and is
C 
represented by β  
 
Y 
The Consumption function is composed of autonomous consumption (α ) and induced
consumption ( (βY ) .
The autonomous part of consumption does not depend on disposable income. Thus it is
the consumption when income is zero. There is consumption at zero income because
consumption also depends on other factors e.g. transfer payments and savings.

Graphically, the consumption function is presented as follows:


C


C α  βY




α
Y




1

, Average propensity to consume, (APC) is the proportion of disposable income that is
spent on consumption. It is given by C/Y.
Therefore: from the above consumption function,
α
APC = C = α  βY = + β ,
Y Y Y
C dc
MPC = β = =
Y dy




Savings Function
It describes the total amount of savings at each level of disposable personal income.
Savings is the difference between disposable income and consumption.

Savings function is given by:
S=Y–C

Given the consumption function, we can derive the savings function.

Suppose C = α  βY, then
S = Y - α  βY  S = -α  Y  βY ,

Therefore, S =  α  (1  β )Y is the savings function.

S


S α  (1  β )Y




α Y




The savings function is upward sloping, implying that savings is an increasing function of
income.
The slope of the savings function is the marginal propensity to save (MPS).


2