Consumption, Savings

and Investment Theory

Consumption Theory
Definition: The purchase of goods and services by
individuals or households which are produced by firms.
According to John Maynard Keynes, a person would
increase his consumption as his income increases, but the
expenditure will be less than the increase in income.
(consumers will spend only a part of the increase in
their income and save the rest).
Income = Consumption + Saving
Y =
C
+ S

Consumption Function
Shows the relationship between the consumption
level and the income level.
General equation for a linear consumption
function can be written as below:
C = a + bYd
Where,
C = consumption expenditure
a = autonomous consumption
b = marginal propensity to consume
Yd = disposable income

Consumption Function, cont..

Autonomous consumption: It does not
depends on the income level whereby it is the
part of consumption when the consumers
income level is zero.
Average propensity to consume (APC):
defines the relationship between total income
and total consumption. APC is defined as a
fraction of the total income spent on
consumption as a whole. APC = Total Consumption
Total Income

C
Y

Consumption Function, cont..

Marginal Propensity to Consume (MPC): defines
the relationship between a change in total
income and a change in total consumption.
MPC = Change in Total Consumption
Change in Total Income
=

C
Y

Savings Theory
Keynes argued that savings is divided
into autonomous savings and induced
savings.
Autonomous saving: the part of savings
that does not depend on the income level
and occurs when there is autonomous
consumption. So, the expenditure comes
from savings which referred to as
autonomous savings.

Savings Theory, cont..

Induced savings: Part of the income.
The higher the income, the higher the
amount of savings and vice versa.
Breakeven Income: The level at
which households consume all their
income. Thus, savings equals zero.

Savings Theory, cont..

Average Propensity to Save (APS): defines the
relationship between total income and total savings.
APS is defined as a fraction of total income that is
saved.
APS = Total saving = S
Total Income
Yd

Marginal Propensity to save (MPS): defines the

relationship between change in total income and
change in total savings.
MPS =

S
Yd

Savings Function
Shows the relationship between savings and income level.
Savings function can be derived from the consumption
function and vice versa.
General equation for a linear savings function can be
written as follows:

S = -a + (1 b)Yd
where,
S = savings
-a = autonomous saving (does not depends on income level)
1-b = marginal propensity to save (MPS) because MPC +
MPS = 1
Yd = disposable income

Consumption & Savings Schedule

Y=C

C
Breakeven

C = 100 + 0.65Y

a = 100

285.7

National Income
S = -100 + 0.35Y

285.7
-100

National Income

Lets test your understanding

S

S = f (Y)

B
160
0
-200

a.
b.
c.
d.
e.
f.
g.

1200

2000

Determine the autonomous consumption and autonomous saving.

Find the MPC and MPS.
Write the consumption function and saving function.
How much do households plan to save if income is RM1500 m?
How much is the NI when households planned to save RM120 m?
Find the value of B in the diagram above.
Calculate the breakeven income level

Investment Theory
It refers to the spending on purchases and
accumulation of capital goods such as
buildings, equipment and additions to
inventories.
The investment function refers to
inducement to invest or investment demand.

Investment Theory, cont..

There are two types of investment:
Autonomous Investment: fixed and independent of
income. The amount of investment can be influenced by
other factors such as interest rates, repayment rates,
business expectations and technology developments.
Ex: capital depreciation.
Investment

Autonomous Investment

Income

Investment Theory, cont..

Induced Investment: Depends on the national
income. As national income increases, induced
investment will also increase since a higher
national income attracts more investors to invest.
Investment
Induced
Investment

Income