The Consumption Function in Macroeconomics

What do you think is the largest driver in an economy? Is it government spending on various schemes or foreign investment? Or perhaps it is exports and imports? Although this driver varies from one country to another, in almost all the countries in modern times, the largest contributor to GDP is domestic consumption, in other words, the goods and the services that are purchased by the citizens.
 

As the title of this segment suggests, in this segment, you will learn how consumption drives demand in an economy. Now, if you recall the formula for GDP, which is Y = C + I + G + X - M, ‘C’ represents household consumption.
 

So, in the upcoming video, you will learn how consumption works, what its components are and how it is calculated.

So, in the video, you learnt that household consumption can be modelled into a function, which can be expressed as follows:

C = A + M * D, where

1. C = consumption,
2. A =  Autonomous spending (spending a person would do irrespective of their income),
3. M = Marginal propensity to spend or consume or MPC (what percentage of the disposable income people spend) and
4. D = Disposable income (the income left to spend after paying taxes).

Through the consumption function graph, you learnt the following important point: with an increase in the levels of disposable income, the marginal propensity to consume decreases. This happens because people with lower disposable incomes tend to spend more, whereas people with higher disposable incomes do not, as they already have enough money to spend. 
 

So, people with higher disposable incomes are less likely to spend any additional sum that is given to them. This helps governments make decisions regarding where they can put money such that it gives the highest multiplier.