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When a household receives more income, it consumes some and saves some.įigure 16.14 "The Consumption Function" shows this relationship. This says that not all additional income is consumed. We also assume that the marginal propensity to consume is less than one.The smaller the marginal propensity to consume, the stronger is the consumption-smoothing effect. Consumption increases as current income increases, and the larger the marginal propensity to consume, the more sensitive current spending is to current disposable income. The marginal propensity to consume captures the present it tells us how changes in current income lead to changes in current consumption. We assume that the marginal propensity to consume is positive.It captures both the past and the future. If a household has accumulated a lot of wealth in the past or if a household expects its future income to be larger, autonomous consumption will be larger.
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Households consume something even if their income is zero. We assume autonomous consumption is positive.More specifically, we frequently assume that consumption is related to disposable income through the following relationship: consumption = autonomous consumption + marginal propensity to consume × disposable income.Ī consumption function of this form implies that individuals divide additional income between consumption and saving. So as disposable income increases, consumption also increases but not as much. We typically suppose the consumption function is upward-sloping but has a slope less than one. It is intended as a simple description of household behavior that captures the idea of consumption smoothing. The consumption function is a relationship between current disposable income and current consumption.