3.5: The Consumption Function

The consumption function is a foundational concept in macroeconomics, describing the relationship between income levels and household spending. Represented by the equation C = a + bY, it delineates two distinct components of consumption behavior. The constant term “a”, known as autonomous consumption, accounts for expenditures that occur irrespective of income. These are essential purchases financed through savings, credit, or social assistance, reflecting baseline living costs such as food, shelter, and healthcare.

Induced Consumption and Marginal Propensity to Consume

The second term, “bY,” captures induced consumption, where b is the marginal propensity to consume (MPC)—the fraction of additional income that is spent rather than saved. A typical value for b, such as 0.75, suggests that for every additional unit of income, 75% is directed toward consumption. If a = 200 and b = 0.75, then at an income level Y = 100, total consumption C becomes:

C = 200 + 0.75 × 100

The graphical representation of this function is a straight line with a positive slope less than one, beginning above the origin. This upward slope indicates that as income increases, consumption also rises, but not on a one-to-one basis. The intercept above the origin emphasizes that some level of consumption exists even when income is zero.

Aggregation and Economic Significance

Aggregating individual consumption functions yields the aggregate consumption function, a key tool in macroeconomic analysis. It enables economists to predict how shifts in national income impact overall demand, influencing policy decisions related to taxation, welfare, and fiscal stimulus. While the linear form simplifies analysis, actual consumption patterns may reflect nonlinearities due to wealth effects, credit constraints, or behavioral factors.

The consumption function explains how much people spend on goods and services at different levels of disposable income. Economists represent this relationship with an upward-sloping line, often written as C = a + bY_d.

Here, ‘a’ represents autonomous consumption—the amount people spend even when their disposable income is zero. It reflects basic needs that are met through savings or borrowing.

‘b’ is the marginal propensity to consume and acts as the slope of the consumption function. It shows how much consumption increases with a one-unit increase in disposable income.

The term ‘bY_d’ represents induced consumption, which is the portion of spending that changes directly with disposable income.

For example, if a = 200 and b = 0.75, then with a disposable income of 100, C equals 275.

Although the function is shown as a straight line for simplicity, in reality, people's spending patterns may vary.

Economists combine all household consumption functions to construct the aggregate consumption function, which shows how changes in disposable income impact total spending in the economy.