Consumption and the Aggregate Expenditures Model

Read this chapter to examine consumption and its determinants within the aggregate expenditures model. Consumption is the largest component of Aggregate Demand the United States, therefore, the factors that determine consumption, also determine the success of the economy.

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 = ΔC/ΔYd and the marginal propensity to save is MPS = ΔS/ΔYd. 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.