Discussion Question 5
Consumption function: is the relation of consumption with its determinants. Graphically drawn as:.
Mathematically it is written as:
C = C + c(Y – T)
C: Consumption Spending
C: Exogenous Consumption
c : Marginal Propensity to Consume (0 < c < 1)
Explaining the main components:
Exogenous consumption: factors other than disposable income that affect consumption. So when consumers feel optimistic about their future, they will generally spend more and save less at any given level of disposable income. Reversely if consumers feel pessimistic about their future then the opposite will occur, where they will spend less and save more at all level of disposable income. An example of where the exogenous consumption would increase would be in times of economic boom, where share prices rise and property prices increase. Consumers would feel wealthier and hence tend to spend more rather than save, therefore increasing exogenous consumption. In times of economic recession however, consumers would feel poorer and uncertain, so they would save more and spend less hence driving exogenous consumption down.
Marginal propensity to consume: is the how much consumption rises for every extra dollar of disposable income. The assumption for marginal propensity to consume is that when a consumer receives a dollar extra of disposable income, a part of the dollar will be spent and the rest is saved. This means consumption will increase, but less than the full extra dollar. This is why the marginal propensity to consume denoted by c will always be greater than 0 but less than 1.
Multiplier:is the short term used for the income-expenditure multiplier. The theory behind the multiplier is that when consumer spending increases or decreases, the actual fluctuation that affect exogenous consumption will be multiplied by the multiplier denoted by c. The reason for this...