Consumption/
Saving/Investment function
CONSUMPTION FUNCTION
• It refers to functional relationship between consumption and national
income
C= f (Y)
• It represents the willingness of household to purchase goods and services at
given level of income
CONSUMPTION FUNCTION
INCOME (Y) CONSUMPTION (C)
0 40
100 120
200 200
300 280
400 360
500 440
600 520
TYPES OF PROPENSITY TO CONSUME
• Average Propensity to consume
• Marginal Propensity to consume
AVERAGE PROPENSITY TO CONSUME
• Refers to the ratio of consumption expenditure to corresponding level of
income
APC = C/Y
Example: If income of a person is Rs 1000 and consumption is Rs 700
APC = 700/1000 = 0.70 = 70%
AVERAGE PROPENSITY TO CONSUME
POINTS TO REMEMBER
• As long as consumption is more than income APC>1
• At break-even point APC=1
• When consumption is less than income APC< 1
• APC can never be zero
• APC falls with increase in income because the proportion of income spent
on consumption keeps on decreasing
MARGINAL PROPENSITY TO CONSUME
• It refers to ratio of change in consumption expenditure to change in total
income
MPC = ∆C/∆Y
• It shows exactly what proportion of change in income is spent on
consumption
MARGINAL PROPENSITY TO CONSUME
INCOME CONSUMPTION CHANGE IN CHANGE IN MPC
(Y) (C) CONSUMPTION INCOME (∆C/∆Y)
(∆C) (∆Y)
0 40 - -
100 120 80 100 0.80
200 200 80 100 0.80
300 280 80 100 0.80
400 360 80 100 0.80
500 440 80 100 0.80
600 520 80 100 0.80
POINTS TO REMEMBER
• MPC varies between 1 & 0
If the entire additional income is consumed then S=0 and MPC=1.If entire additional
income is saved then C=0 and MPC=0
• MPC of poor is more as compared to rich because poor people spend a greater
percentage of their increased income on consumption as most of their basic needs
remain unsatisfied. Wheras rich people spend a smaller proportion as they already
enjoy a high standard of living
• MPC falls with increase in income. It happens because an economy becomes
richer, it has the tendency to consume smaller percentage of each increment to its
income
DIFFERENCE BETWEEN APC AND MPC
SAVING FUNCTION/PROPENSITY TO
SAVE
• Saving function refers to the functional relationship between saving and
national income
• Saving function is also known as Propensity to Save, and is represented
S=f (Y)
• Saving function or propensity to change shows the saving of households at a
given level of income during a given time period
SAVING FUNCTION/PROPENSITY TO
SAVE
INCOME CONSUMPTION SAVING
(Y) (C) (S)
0 40 -40
100 120 -20
200 200 0
300 280 20
400 360 40
500 440 60
600 520 80
EXPLANATION OF THE CURVE
• National income is measured on the X-axis and saving is measured on the Y-axis
• Saving curve (ss) starts from point S on the Y-axis
• Saving curve crosses the X-axis at point R, which is known as break-even point
,saving is zero (C=Y)
• After the break-even point saving is positive S>C
• Slope of saving curve is positive, which indicates positive relationship between
saving and income
TYPES OF PROPENSITY TO SAVE
The two types of Propensities to Save are
• Average Propensity to Save
• Marginal Propensity to Save
AVERAGE PROPENSITY TO SAVE
• Refers to the ratio of saving to the corresponding level of income
APS= Saving / Income
AVERAGE PROPENSITY TO SAVE
INCOME SAVING APS= S/Y
(Y) (S)
0 -40 -
100 -20 -0.20
200 0 0
300 20 0.067
400 40 0.10
POINTS TO REMEMBER
• APS can be zero: When the savings is zero, APS will be zero. This point is also known as
Break-even Point.
• APS can never be one or more than one: As savings can never be equal to income
(because of autonomous consumption) and more than income.
• APS can be negative or less than one: APS can be negative at all the income levels lower
than the Break-even Point, because of dissaving in the economy.
• APS increases with an increase in income: As the income increases, APS also increases
because the proportion of income saved keeps on rising.
MARGINAL PROPENSITY TO SAVE
• Refers to the ratio of change in saving to change in total income
MPS= Change in saving ( ∆S)/ Change in income (∆Y)
MARGINAL PROPENSITY TO SAVE
INCOME SAVING CHANGE CHANGE MPS
(Y) (S) IN IN
SAVING INCOME
(∆S) (∆Y)
0 -40 - - -
100 -20 20 100 0.20
200 0 20 100 0.20
300 20 20 100 0.20
400 40 20 100 0.20
MARGINAL PROPENSITY TO SAVE
• MPS varies between 0 and 1
If the entire additional income is saved i.e ∆C= 0,then MPS=1
If entire additional income is consumed then ∆S=0,then MPS=0
Hence the value of MPS varies between 0 and 1
Comparison between APS and MPS
RELATIONSHIP BETWEEN APC & APS
• APC + APS =1 (because income is either used for consumption or saving)
• We know
Y= C+S
Dividing both sides by Y, we get
Y/Y = C/Y + S/Y
1 = APC + APS
•
RELATIONSHIP BETWEEN MPC & MPS
• MPC + MPS= 1 (because change in income is either used for saving and
consumption)
• We know
∆Y= ∆C + ∆S
Dividing both sides by ∆Y, we get
∆Y/∆Y = ∆C/∆Y + ∆S/∆Y
1 = MPC + MPS
DERIVATION OF SAVING CURVE FROM
CONSUMPTION CURVE.
• We know that Y = C + S, which means that as Consumption and Savings
together make up income, the consumption curve and saving curve are
complementary curves.
• Therefore, it is possible to derive the saving curve from consumption curve
and consumption curve from saving curve. Let us derive saving curve from
consumption curve.
DERIVATION OF SAVING CURVE FROM
CONSUMPTION CURVE
DERIVATION OF SAVING CURVE FROM
CONSUMPTION CURVE
• First, draw a consumption curve CC with OC as autonomous consumption
and a 45° line OY representing the income curve as shown in the below
graph.
• The point where the consumption curve CC and income curve OY intersects
is the break-even point; i.e., Point E. At this point Consumption is equal to
Income and Average Propensity to Consume is one
DERIVATION OF SAVING CURVE FROM
CONSUMPTION CURVE
• At zero income level, OC is the autonomous consumption, which means that
savings at zero income level will be OS.
• Therefore, the savings curve will start from point S on the negative Y-axis
because, at zero level of income, savings are negative.
• Now the point where the CC curve and OY curve intersects; i.e., point E is
the break-even point. It means that at this point C = Y, APC = 1, and
Savings = 0.
• Therefore, the savings curve will intersect the X-axis at point R. Now, join
the points S and R and extend it further to get the Saving Curve SS.
DERIVATION OF CONSUMPTION
CURVE FROM SAVING CURVE
