Consumption is the total quantity of goods and services purchased and used by consumers during a specified period of time. Consumption is also described as expenditure on goods and services at a given period of time. It is the expression of total consumer demand. Types of consumption includes: durable goods, non-durable goods and services. Durable goods involves consumption expenditure on certain items which are durable in nature eg, houses, vehicles, furniture, machines etc, non-durable goods involves consumption expenditure on goods that are not durable in nature, eg, food, clothing, water etc. Services involves consumption expenditure on general services, eg, legal fees, medical fees, entertainment fees, educational fees etc.Factors which determine the level of Consumption are:
1. Savings: The level of savings influences consumption. High savings influences consumption and tends to reduce the level of consumption.
2. Level of income: The higher the income, the higher the level of consumption.
3. Availability of credit facilities: Availability of credit facilities either to individuals or firms tends to increase the level of consumption.
4. Income distribution; Equitable distribution of national income will increase the disposable income of individuals thereby increasing the level of consumption.
5. Possession of assets: Revenue generated by assets increases the income of their owners and this tends to raise the level of consumption.
6. Rate of taxation: High taxation reduces the income of people and this reduces the level of consumption.
7. Interest rate; If the interest rate received is high, it will generally increase the income leading to a rise in the level of consumption.
8. Profit earned: High profits earned either by individuals or firms increase income thereby resulting in a rise in the level of consumption.
9. Future expectation: expectation of rise in the prices of goods and services will elad to a rise in the level of consumption expenditure and vice versa.Relationship between savings, Investment and Consumption
Savings, investment and consumption are closely related. We save in order to accumulate capital for investment and for many other personal reasons. There will be no investment without savings. Investment, in turn, creates employment and income for people. Without it and, therefore, without income, we shall have nothing to save and nothing to spend on consumer goods and services.What we do not spend is what is saved. Consumption, therefore, is affected by decisions to spend. If we spend all our income, there will be no capital accumulation for investment. Therefore, the community’s income is made up of savings, investment and consumption. Savings, investment and consumption are related to income with the use of the following formula:
Y= C + S
Y= C + I
S= I; where Y is income, C is consumption expenditure and I is investment expenditure.
Propensities to Consume
Propensities to consume can be in two groupings:I. Average propensity to consume (APC): The APC is defined as the proportion of the national income that is consumed. In order to calculate APC, the total national consumption is divided by the total national income. The formula is:
APC= Total National Consumption/Total National income = C/Y.For example, the total national income for Belarus is $20 million and the total national consumption is $5 million, to find the APC, it will be $5m/$20m = 0.4II. Marginal propensity to consume (MPC)
The MPC is defined as the relationship between changes in income and changes in consumption. It shows the extent to which the level of consumption changes as a result of a change in income. It, therefore, shows the proportion of any addition to income, which is used for consumption.
MPC = changes in consumption/Changes in income = dC/dYFor example, if the monthly income of an individual increases from $10,000 to $15,000 and increases his level of consumption from $4,000 to $6,000, his marginal propensity to consume can be calculated as follows:
initial income per month= $10,000
New income per month= $15,000
Changes in income (dY) = $15,000-$10,000= $5,000
Initial consumption per month= $4,000
New consumption per month= $6,000
Changes in consumption (dC)= $6,000-$4,000= $2,000.
MPC= dC/dY= $2,000/$5,000= 0.4 This is low and hence good for his savings and financial growth.Propensity to save
This is also in two groupingsI. Average propensity to save (APS): The average propensity to save (APS) is defined as a measure of the proportion of income which is saved (not spent on consumption). It shows the expected amount of savings at different levels of income.APS= Total National Savings/Total National Income = S/Y
The APS increases with increasing income. As the level of income increases, one is able to save more money.
Note that APC + APS = 1.For example, if Makama Incorporation firm earns $80 billion and spent $50 billion on procurement of working materials, the APS of the firm would be;
Total income= $80 billion
Total expenditure= $50 billion
Total savings = Total income – Total expenditure = $80 billion – $50 billion = $30 billion
Therefore, APS = Total savings/total income = $30 billion/$80 billion = 0.38II. Marginal Propensity to save (MPS): The marginal propensity to save (MPS) is a measure of the relationship between changes in the level of savings and changes in income. It shows the change in savings brought about by a change in income level. MPS is calculated using the formula
MPS= Changes in savings/Changes in income = dY/dYFor example, if the daily income of a factory worker increased from $500 to $700 and he increases his level of consumption by $80, his marginal propensities to save and to consumer can be calculated as follows;
Initial income per day= $500
New income per day= $700
Change in income per day (dY) = $700-$500 = $200
Change in consumption (dC)= $80I. MPC = Changes in consumption/changes in income = dC/dY= 80/200 = 0.4
II. MPC + MPS = 1
MPS = 1- MPC; 1-0.4= 0.6Alternatively,
Changes in level of consumption = $80
changes in level of savings = $200- $80 = $120
MPS = dS/dY= #120/$200= 0.6Elementary theory of the Multiplier
The theory of the multiplier states that an increase in consumer or business investment spending in a country would produce a multiplier effect by raising the level of national income. In other words, the multiplier is the figure by which an increase in total expenditure in the country may be multiplied to get the resulting increase in the national income. The multiplier is also referred to as the ration of changes in national income to changes in the autonomous expenditure which led to it. The multiplier effect can be as a result of changes in consumption expenditure, which is known as consumption multiplier, or investment changes, which is known as investment multiplier.Using the investment multiplier as an example, if a $3 billion increase in total investment in a country leads to a $9 billion increase in national income, the multiplier is therefore equal to 3. The multiplier is a system used in all types of spending in a country by individuals, firms and the government.The multiplier, denoted by K, is usually calculated with the aid of a formula.
I. K= 1/(1-MPC) = 1/MPC
II. K= dY/(dC or I).
where K is the Multiplier, MPC is the MArginal propensity to consume, MPS is the marginal propensity to save, Y is the change in national income, C is the consumption expenditure and I is investment.A knowledge of the marginal propensity to consume or the marginal propensity to save helps us to know the multiplier. And a knowledge of the multiplier helps us to know the extent to which consumption expenditure or investment should be increased or decreased to achieve a desired level of income. The higher the MPC, the higher the multiplier effect and the higher the MPS, the lower the multiplier effect. Therefore, a higher MPC increases national income while a higher MPS will reduce it.Suppose the MPC is 0.75. This means that 0.75 of every additional income will be consumed. The amount saved will be 1-0.75 = 0.25, since MPC + MPS = 1. The multiplier, the MPC and the MPS are related by the formula:
Since 1-MPC = MPS, this implies that; K=1?MPS, where K is the multiplier.
For example, if the marginal propensity to consume is 0.8, we can deduce by how much the expenditure can be increased to increase income by $10,000. Here are the steps to take;
K= 1/(1-MPC) = 1/(1-0.8)= 1/0.2= 5.
The Multiplier K has a value of 5.
Therefore, K= dY/dC
C= $2,000.Here is another example, if the marginal propensity to consume is 0.75, we can calculate by how much the national income can increase if the government expenditure is increased by $8 billion. Here is the trick;
K= 1/(1-MPC)= 1/(1-0.75) = 1/0.25 = 4
K= 4; but K= dY/dG
4= dY/$8 billion
dY= $8 billion X 4 = $32 billion.Final example, when the government investment changed from $500 billion to $800 billion, the marginal propensity to consume was 0.6. We can determine the changes in national income level by applying the following tricks;
dY X (1-MPC) = dI
dY= ($800 billion-$500 billion)/(1-0.6)
dY= $300 billion/0.4
Changes in national income level is $750 billion.Equilibrium level of Income
This is a situation where the total amount people wish to save equals total investment of business units. It refers to a point at which aggregate savings equals aggregate investment. At equilibrium level of income, there is a balance between demand and supply and there will be no tendency to increase or decrease output. The business sector is satisfied that the right volume of output has been achieved and there will be no tendency to alter it. For equilibrium national income to be maintained, the volume of total withdrawals from the circular flow of income must be equal to the total injections. For instance total amount of savings must be equal to total value to investment goods, and aggregate expenditure must be equal to total output.Income earners (or households) can spend their income on consumption goods or save it. Hence, Y= C+S. On the other hand, the firms can produce either consumption goods or investment goods. Hence, Y= C+1. Therefore, for Y to be constant, the level of savings (S) must be equal to investment (I). By implication the amount of consumption goods and services produced by firms will be equal to the aggregate demand by the households.”Whew”….. Enough of the economics now. thanks for reading