Chapter Three
Consumption and Saving
1. Consumption and saving analysis
 Factors affect consumption
current disposable income;
foresight of income and price;
interest rate for consumer’s
credit;
catch up with somebody;
social security system;
personal wealth

Factors affect saving
precaution;
foresight;
interest rate;
independence;
enterprise;
pride;
avarice and miser
2. Consumption Function

Definition
The relationship between consumption and
factors that affect consumption is described
by the consumption function.
 Especially we assume the that consumption
increases with the level of disposable income:
C = a + b Yd

Autonomous consumption
variable a in C function ----represents the
level of consumption when income is zero---the intercept on vertical axis of the C-curve

Induced Consumption
be varied with income level---- the slope of
the consumption curve and b Yd in C
function

Propensity to consume
Average propensity to consume (APC)
APC = C/Yd -----is the proportion of
consumption to income .
Marginal propensity to consume (MPC)
MPC = ∆C/∆Y ------ is the increase in
consumption per unit increase in income. It is
represented by variable b in C function.
3. Short-run & long-run consumption curve
 “Paradox of consumption
function”
 The shift of the Cs curve
 Derivation of the CL-curve
 Explain of the shift in the
short-run curves
4. Saving Function

Definition------Saving is equal to income
minus consumption.

APS & MPS :
MPC+MPS=1 ; APC+APS=1

Saving curve

Saving function
S = Yd - C = - a + (1-b) Yd
5. Modern Consumption Theory

Absolute Income Theory

Relative Income Theory

Life-cycle Theory
Some assumptions
Basic function
C = a WR + c YL
where:
a ---- MPC out of wealth
WR ---- real wealth
c ----- MPC out of labor income
YL----- labor income
With lifetime consumption equal to lifetime
income, we have
C×NL = YL ×WL
C = YL × WL/ NL
Case: Numerical example
Summarize:
C is constant over the consumer`s lifetime
and financed by lifetime income plus initial
wealth.
During each year, a fraction,1/(NL - T), of
wealth will be consumed, where (NL - T) is the life
expectancy.
Current consumption spending depends on
current wealth and lifetime income.

Permanent income theory
A) The form of the theory:
C = c YP
YP----- permanent disposable income
c------ is the MPC
B) Estimating of the YP:
YP = Y-1 +θ(Y - Y-1)
=θY+(1-θ)Y-1
C) Permanent Income and Consumption
C = cYP = cθY + c(1-θ)Y-1