Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Consumption function

The amount that households choose to consume depends on a number of different variables.

The most important is their disposable income, which is household income after tax. Total disposable income in an economy equals Y – T, where Y is total income (GDP) and T is total taxes households pay to the government.

You can express the relationship between consumption and disposable income mathematically with a consumption function:

In words, this expression says that consumption (C) is a function of disposable income (Y – T). Specifying the consumption function explicitly as a linear relationship shows how consumption varies with disposable income:

c₀ is called the level of autonomous consumption, that is, consumption independent of the level of disposable income. c₁ is called the marginal propensity to consume and tells you how much consumption increases when disposable income increases by £1. It’s a number between 0 and 1.


Figure 7-1 shows a graph of the consumption function. The line intersects the y-axis at c₀ and the slope of the line is equal to c₁. If autonomous consumption increases, this shifts the entire consumption function upwards, whereas an increase in the marginal propensity to consume makes the consumption function steeper.


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Figure 7-1: The consumption function.

You may be thinking, how can households consume even if they have no disposable income? Good question: they either use their savings or borrow against future income.

The consumption function makes clear that any increase in income (Y) raises consumption (C), but by less than the increase in income. Equally, any decrease in taxes (T) also increases consumption by raising disposable income: because the marginal propensity to consume is less than 1, this increase in consumption is less than the amount by which

taxes have fallen.