Household spending accounts for nearly two thirds of total (aggregate) demand for goods and services in the economy. It is not surprising that macro economists spend a large amount of time researching trends in consumer spending as they build up a picture of how the British economy operates.

There is a positive relationship between disposable income (Yd) and consumer spending (Ct). The gradient of the consumption function gives the marginal propensity to consume. As income rises, so does total consumer demand. When the consumption function cuts the 45 degree line, income = spending (i.e. saving = zero).

A change in the marginal propensity to consume causes a pivotal change in the consumption function. In this case the marginal propensity to consume has fallen leading to a fall in consumption at each level of income.

Key Consumption Definitions

·        Average propensity to consume = Total consumption divided by total income

·        The marginal propensity to consume (MPC) is the change in consumption resulting from a change in disposable income. For example if out of an increase of income of £2000, £1600 is spent and £400 is saved, the marginal propensity to consume would be £1600 / £2000 = 0.8.

Definitions Of Saving

Saving is act of postponing consumption. Total savings (S) = Disposable Income (Yd) - Consumption (C).  Gross Income (Y) can be spent (C), saved (S) or paid in tax (T).

·        The average propensity to save (APS) is the proportion of disposable income that is saved rather than spent. This is also known as the household savings ratio

·        The marginal propensity to save (MPS) is the change in saving resulting from a change in disposable income. For example if out of an increase of income of £2000, £1600 is spent and £400 is saved, the marginal propensity to save would be £400 / £2000 = 0.2.

·        The marginal propensity to consume + the marginal propensity to save = 1