CONSUMPTION AND SAVINGS

--- Group 3 ---

OVERVIEW
Income determination- refers to economic
income which is earned through economic
activities.
national income reflected in the value of
production
personal economic income-income earned by
households as factor contributors

Assumptions to emphasize
essential features of income
determination:
Households are the only factor contributors
Personal savings is the only leakage from
the system
National Income (NI) is equal to Gross
National Product (GNP)

Basic Concepts of
Consumption
Consumption- is the act of using goods and
services to satisfy human wants.
Business consumption- indirectly satisfies
Household consumption- directly satisfies
- one of the determinants of National/Factor Income
Current consumption
Expenditures on capital goods

Consumption Function

Y= C + C
Where:
Y = Factor Income
C = Borrowings from economys
savings
C = Change in consumption

stock of

Multiplier Concept
Multiplier- the process of generating income through the
circular flow exchange between the households and the
firms.
Multiplier coefficient- measures the average number of times
every peso of inflow circulates and changes hands in the
system as income.
Marginal propensity to consume (MPC)- consumption factor of
the multiplier
Marginal propensity to save (MPS)- savings factor of the
multiplier

FORMULA:
S= i
i= Y - C orY= i + C
Where:
S= aggregate savings from currently
generated income
i= inflow

Four values used to assess the saving and

spending of household disposable
income:
1. APC
2. APS
3. MPC
4. MPS

 Average Propensity to Consume (APC)

Real consumption divided by real
disposable income
The proportion of total disposable income
that is consumed

Real consumption
APC =
Real disposable income
12-9

 Average Propensity to Save (APS)

Real saving divided by real disposable
income (DI)
Saved proportion of real DI

Real saving
APS =
Real disposable income

12-10

 Marginal Propensity to Consume (MPC)

The ratio of the change in real consumption
to the change in real disposable income

MPC =

Real consumption
Real disposable income

12-11

 Marginal Propensity to Save (MPS)

The ratio of the change in saving to the
change in disposable income

MPS =

Real saving
Real disposable income

12-12

FORMULA:
Y= CM
M=
1 =
1- (MPC)

1
MPS

Where:
M= multiplier coefficient
(MPC)= Marginal propensity to consume
MPS= 1-(MPC)= Marginal propensity to save

Relationships
Average propensity to consume and average
propensity to save must sum to 100% of
total income. (APC + APS = 1)
Marginal propensity to consume and
marginal propensity to save must sum to
100% of the change in income. (MPC +
MPS = 1)

CONCLUSION:
The smaller the MPS, the larger
the multiplier.
The larger the MPC, the larger
the multiplier.

Sample Problem:
If your disposable income increases from
P50,000 to P57,500 a year, and your savings
increases from P25,000 a year to P28,000 a
year.
Calculate
MPS
MPC
Multiplier Effect
GDP (assume AD is P4,500 )

Consumption and savings

Savings outflow- yields the additional income that
the system generates by the multiplier process.

Dissavings or net borrowings- yields the current

income levels before the point where inflow is equal
to outflow (S = i)

Net Savings- generated when the income levels

beyond the said point yield accumulated outflows
that more than replenish the stock

SAVINGS
Saving
The act of not consuming all of ones current income
Whatever is not consumed is, by definition, saved.
Saving is an action measured over time (a flow).
Savings are a stock, an accumulation resulting from the
act of saving in the past.

Dissaving
Negative saving; a situation in which spending exceeds
income

Why do People Save?

Life Cycle Motives Income is Not Smooth
Across Time. Households save, in part, to
transfer income from high income periods to
low income periods.
Precautionary Motives Households like to
achieve a buffer stock of wealth in the case of a
possible bad outcome. If households have a
buffer stock of saving, bad outcomes in terms
of income dont result in really bad outcomes
in terms of consumption.

Summary: Determinants of
Savings

An increase in

Causes
savings to

Reason

Current income

Rise

Part of the extra income is saved

Expected future
income

Fall

Anticipation of increased future

income induces current
consumption

Wealth

Fall

New stock of wealth secures future

consumption level and makes
more of current income free for
consumption.

Expected real
interest rate

Not clear.
Probably rise.

Increased rate produces higher

pay-offs in future and thus may
make savings more attractive.
20

Graphical and Tabular

Illustrations

Factors of Consumption
1) Framework
Personal consumption- is the households
realized demand to satisfy current needs.
) Same increase in income yields greater consumption
and marginal propensity to consume
) Income level varies directly with consumption
depending on the size of inflows
) Savings factors indirectly determine consumption and
savings can be traded for each other in the same
personal income.

2) Taste and Preference

- depends on how the product satisfies
ones desires.
They vary across different :
1. racial
2. ethnic
3. age
4. occupational groups

Several underlying reasons why

consuming units have different
attitudes toward consumption:
1. According to Duesenberrys Relative
Income Hypothesis:
- states that the differences in consumption
behaviour could be explained by the
differences in income level relative to what
one is accustomed to.

Values affects attitudes

Gaya-gaya system- influences
consumption not because of product
utility but simply because others also
possess the goods.

Colonial mentality- regards locally made

goods as inferior to their foreign
counterparts

3) Population
Population size- also determines
consumption needs and, therefore, affects
consumption expenditures with a given
income.

 An increase in household size with income and

other factors as constant may decrease the
propensity to consume and increase savings at
the expense of non-essential items in the
consumption basket.
A change in population distribution among
consuming units of different tastes and
preferences can also alter aggregate propensity
to consume and consumption assuming
income and other factors as constant

4) Income
Level of income can increase with more infusions in the
circular flow
Increase in aggregate consumption subsequently
multiplies into higher income levels
Propensity to consume varies across consuming units to
which income is distributed because of the varying
influence of demand factors
Example:
Tastes and preferences
Income level: In Low income bracket & In High income bracket

5) Price Level
Individual product demand- inversely proportional to
price due to change in purchasing power and
substitution with other products
Aggregate volume of consumption is inversely
proportional to price but only due to a change in
purchasing power
A change in the general price level can spur further
consumers reaction through a shift in individual
demand curves which changes aggregate
consumption expenditures

Example:
The general price level drastically increased by
around 40% in the next several months from the
outbreak of economic crisis in 1983.
Therefore:

Price
*in value

Demand

Spending* Save

CONSUMPTION CHANGES

6) Innovation and Promotion

- can expand the line of consumers choice and extend
the influence of demand factors on consumption and
propensity to consume income.
Introduction of new products can create demand and
increase aggregate consumption with the same taste
or preferences and level of income
Promotions and advertising serve as media of
introducing new products in the market which create
demand and consumption.

ENGELS LAW And the

Compositional Change in
Consumption Expenditure

Ernest Engel- a German economist in the 19th century

- found a relation between the level of family income

and the composition of its consumption spending.
PRINCIPLE:
As family income level rose, the proportion to total income of
essential items like food decreased (even if actual
expenditure on food rises), while non-essential items like
education and recreation followed the opposite trend.

Engels Law- implies that

changing the relative importance
of items in the consumption
basket depends on how
consumers spend additional
income.

RELATIONSHIP:
Cn results in Cn + Cn and Cn + Cn
y

y + y C + C
At the expense of:

Ce results in Ce + Ce and Ce + Ce
y

y + y

Where:
Cn= Consumption of non-essential items y= Income
Ce= Consumption of essential items = Change
C = Consumption of all items

C + C

Example:
A family that spends 25% of their income
on food at an income level of P50,000
will spend P12,500 on food. If their
income increases to P100,000, it is not
likely that they will spend P25,000 (25%)
on food, but will spend a lesser
percentage while increasing in other
areas.

THE END

GROUP III
Jennifer Bingil
Jasmin Alagasi
Duane Jade Abalos
Kristoffer Carlo Gimenez