Consumption function

Spending in the Economy

The sectors that spend in the economy are:

Consumers

Business Firms

Government

International Sector

Spending in the Economy

AD = C + I + G + Nx

Consumption Expenditure expenditure done by

households on final goods and services

Consumption is the largest component of AD

Consumption spending is relatively stable

Durable Goods

3 Components of Consumption Spending

Nondurable Goods Services

Goods that last a long time

Goods that are consumed very

quickly Work performed for others

Consumption Function

As we earn higher levels of income (Yd) our consumption increases

C

Yd

C

450

45

C

C

Yd

Consumption Function

E

A

B

Equilibrium

We consume all

of our income

Yd = C

Yd > C

Earning more

than we spend

C > Yd

Spending more

than we earn

C

Yd

C

450

C2

C3

Consumption increases at every level

Consumption decreases at every level

Wealth

Wealth includes those things you own such as your property

holdings, stock portfolio, or any other asset that has value.

Wealth is NOT your income

An increase in wealth will increase your consumption

A decrease in wealth will decrease your consumption

Expectations

Expectations deal with expected future changes in income.

If you expect your future income to increase you may increase your spending today

If you expect your future income to decrease you may decrease your spending

today.

I get a job with Google that begins in three months. The job pays more than I now get. I will start increasing my consumption expenditures.

Debt

Debt deals with how much you owe.

If you have a large amount of debt you may decrease your spending

If you have little or no debt you may increase your spending

Real Interest Rate

The real interest rate deals with the interest you pay on purchases that have been

financed – such as buying a large TV at Best Buy.

If the real interest rate fall your consumption may increase

If the real interest rate increases your consumption expenditures may fall.

Taxes

Taxes deals with the taxes you pay on your income.

If the taxes you pay falls your consumption expenditures will increase

If the taxes you pay increases your consumption expenditures will decrease.