Determinants of Consumption
¿ Household income-the most important
¿ Household wealth
¿ Interest rates
¿ Households’ expectations
Consumption Function
¿ Keynes points out that the household consumption is closely related to the income. With the income increase, people will consume more. However, the increase of consumption is not as great as that of income.
¿ Empirical studies also reveal the close relationship between consumption and income but the increase of consumption is on the whole proportional to income.
Permanent Income Hypothesis
(Milton Friedman)
People gear their consumption to their expected lifetime average earnings more than to their current income. The central idea of the permanent-income hypothesis, proposed by Milton Friedman in 1957, is simple: people base consumption on what they consider their "normal" income. In doing this, they attempt to maintain a fairly constant standard of living even though their incomes may vary considerably from month to month or from year to year. As a result, increases and decreases in income that people see as temporary have little effect on their consumption spending.
• Saving is that part of income that is not consumed. Saving equals income minus consumption: S = Y – C
The Determinants of Saving
• There is no single reason why people save
• Some spend virtually all of their disposable income
• Some spend more than they earn
• Americans now save less than 5% of disposable income
• Americans used to save 7-10% of disposable income
Autonomous Consumption versus Induced Consumption
• Autonomous consumption (AC) is the level of consumption when disposable income is “0”
– It is called autonomous because it is independent of change in disposable income
• Induce consumption (IC) is that part of consumption which varies with the level of disposable income
– As disposable income rises, induced income rises
– As disposable income fall, induced income falls
• C = Autonomous C + Induced C
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