Consumption and the Aggregate Expenditures Model

13.1 Determining the Level of Consumption

KEY TAKEAWAYS

  • Consumption is closely related to disposable personal income and is represented by the consumption function, which can be presented in a table, in a graph, or in an equation.
  • Personal saving is disposable personal income not spent on consumption.
  • The marginal propensity to consume is MPC = ΔCYd and the marginal propensity to save is MPS = ΔSYd. The sum of the MPC and MPS is 1.
  • The current income hypothesis holds that consumption is a function of current disposable personal income, whereas the permanent income hypothesis holds that consumption is a function of permanent income, which is the income households expect to receive annually during their lifetime. The permanent income hypothesis predicts that a temporary change in income will have a smaller effect on consumption than is predicted by the current income hypothesis.
  • Other factors that affect consumption include real wealth and expectations.