CONSUMPTION

Meaning
This is the direct and final use of goods and services to satisfy human wants.
The consumption of FMCG and consumes duarbles are called unproductive
consumption because they do not lead to the production of other goods.
The services of doctors, teachers, mechanics etc., are for satisfying human wants. These
services are called productive consumption.
rof. Meyers stated
Consumption is the direct and final use of goods and services in satisfying the wants of
human beings.
Importance
Beginning of all economics activities: !t is an effort to satisfy the desire. The main motto
for every productive activity to ma"e the people consume goods
End of economic activities: #hen the consumption is over, wants comes to an end. That
is why it is the beginning and end of all economic activities
Index of standard of living: $ased on the consumption pattern the standard of living of
the individual is evaluated.
Importance in economic theories: %n the basis of individual consumption behavior, the
law of diminishing marginal utility is formulated. &aw of demand etc.
Importance in income and employment: $ased on consumption the income and
employment theory by 'eynes is formulated. This theory tal"s about when demand
decrease the production will fall down and will lead to employment.
Human wants
Man is a bundle of desire ( desire becomes a want only when the consumer has means
)money* to purchase.
Importance of human wants
#ants are unlimited
#ants of particular nature can be satisfied.
#ants are competitive.
#ants are complementary i.e., gas instead of petrol in case
+ome wants recurs e.g. hunger
+ome wants become habit i.e., consumption of li,uor, cigarettes.
#ants are affected by income !.e., wants of rich and poor
#ants are affected by fashion.
-idden wants i.e., some wants are in sub conscious mind
#ants are affected by social custom.
#ants affected by religion.
Exception to wants
The wants for money can never be satisfied fully.
The wants for prestigious goods.
Classification of wants:
Diagram
.ecessaries of life /0 say li"e foods, clothing and shelter.
.ecessaries of efficiency/0 essential to maintain or increase efficiency of energy and
ability. 1ich diet li"e fruits, mil", protein diet etc.
Conventional necessaries/0 these are necessaries which we are forced to use because of
social custom.
Comforts/0 these goods are included in our life to ma"e it more comfortable or easy.
There must be a clear difference between 2comfort3 and 2necessary of efficiency3.
&u4uries /0 lu4uries is a means which satisfies a superfluous wants . &u4urious car,
electric coo"ers automatic washing machines are some e4amples.
-armful lu4uries -armless lu4uries
These are harmful to man and decreases
their efficiency or destroys health
.either this destroys nor decreases
efficiency
5rin"ing and smo"ing (ir conditioners, heaters, 6ewellery etc.,
///////////////////////////////////////////////////////////////////////////////////////////////////////////
S!IN"S
Meaning: +aving is defined as the difference between disposable income and consumption.
+78/C.
#here +7 saving9 87income9 C7consumption.
!ncome )8* Consumption
)C*
+avings )+* (+
)+:8*
M+
;+:;8
< = > >:<7? @
A =A /=A / /
BA CA /<A / /
<=A <=A A A /
<DA <CA <A A.B A.<C
=?A ==A =A A.D A.<C
The relationship between saving and income is called propensity to save or saving
function where +7 f)8*
This indicates a function relationship .+ is dependent and 8 is independent variable.
This relationship is based on the assumption other things being e,ual
Diagram
-ere it means all the factors that influences on savings are held constant and income and
savings increase by a constant amount.
This diagram shows the propensity to save curves.
a. -ere income is ta"en on the horiEontal a4is.
b. +avings on the vertical a4is
c. The below point 383, where savings are negative because people dis save.
d. (t 283 savings is Eero.
e. 2+3 curve is linear because the rise in income and saving is at constant rate.
#erage propensit$ to sa#e %PS&
This is the ratio of savings to income.
This is by dividing savings by income
(+ 7 +:8
This tells the proportion of each income level that people will save.
FgG / when price is at rs <DA:/, the consumption is rs <CA:/ and the savings is rs <A:/
Therefore (+ is A.AB which means people could save BH of their income.
Diagram
M'"IN( P'OPENSIT) TO S!E %MPS&:
M+ is the ratio of the change in saving to the change in income.
This is also defined as the rate of change in (+.
This is found by dividing a change in saving by a change in income. i.e. ;+:;8
FgG !ncome increase from rs <DA:/ to rs =?A:/ ,
+avings increase from rs <A:/ to rs =A:/.
;8 7 rs BA:/)=?A I <DA*
;+ 7 rs <A:/ )=A I <A*
M+ 7 <A:BA 7 A.<C.
This means <CH of the income is saved.
This means ;+:;8 is constant.
IN!ESTMENT *UNCTION
Meaning: !n ordinary terminology investment means buying stoc"s, bond and securities. This
is not a real investment because they are simply transferred to e4isting assets.
(s per 'eynesian terminology, investment means add to capital e,uipment.
a. This will lead to an increase in the level of income by production.
b. roduction by the purchase of capital goods
T$pes of in#estment
<. !nducted
=. (utonomous
>. rivate
?. ublic
@. Gross J investment
B. !ntended J unintended
In+ucte+ in#estment
Motivated towards profit or income
Factors li"e price, wages J interest changes will influence inducted investment. +imilarly
demand will also influence it.
#hen income increases consumption demand also increases. The income is elastic
!7f)8*.
Diagram
!!< is the investment curve. This shows the investment at various level of income.
!nducted investment is Eero at %8<.
#hen in come rises to o8= then investment at !>8=
!nducted investment may be divided in to
i. (verage propensity to invest
ii. Marginal propensity to invest
,#erage propensit$ to in#est
#hen the income is rs ?A:/ then the investment will be rs ?:/.
!:8 7 ?:?A 7 oH
,Marginal propensit$ to in#est:
There will be a change in the investment when there is change in the income
;!:;8 7 =: <A7 A.=
7 !>a:8=8>
utonomous in#estment
This is also independent against the income level. Thus income is inelastic.
.ormally this is influenced by the factors li"e innovations, inventions, growth of
population J labour force.
This is not influenced by the changes in demand.
These are the investment in economics J social overheads made by government )say
li"e, clams, roads, canals, schools etc*
These autonomous investments are associated with public policy for long/run.
Pri#ate in#estment
The investment made by private investors.
-ighly influenced by profit J the e4pectation on profit is said to be elastic.
This depends on = factorsG namely
o 1ate of interest
o Marginal efficiency of capital
)Fncouraged by marginal efficiency of capital is high or rate of interest is low*
Pu-lic in#estment
!nvestment made by different layers of government or public investment.)+ay li"e
buildings, railway lines, communication power pro6ects etc*
"ross an+ net in#estment:.
(ll investment made in a country is gross investment.
.et investment will remain after depreciating and obsolescence charges from gross
investment.
.et investment 7 gross investment I depreciation J obsolescence charges.
Inten+e+ an+ uninten+e+ in#estment
#hen investment is of planned manner with specific ob6ective then they are intended or
voluntary investment.
-ere entrepreneurs increase investment in order to raise productive capacity towards
favourable demand and price changes. )For this they will invest in machinery which will
reduce cost and increase profit in future*
Marginal efficienc$ of capital/.%MEC&
The decision to invest in new capital asset depend on
o The e4pected rate of return on new investment is greater or less to the rate of
interest to be paid on the funds rose to purchase the asset.
The reality > factors are to be considered while ma"ing investment decision
o Cost of the capital assets
o F4pected rate of return from its lifetime
o Mar"et rate of interest
The summariEed concept of these factors is said to be Marginal efficiency of capital
The prospective yield )(ggregate net return from an assets during its life time* 7 8
+upply price )Cost of producing this assets* 7
FgG / if the supply price of capital asset is rs =AAAA:/ and annual yield is rs =AAA:/ then the
marginal efficiency of the asset is
)=AAA:=AAAA*K)<AA:<* 7 <AH
The marginal efficiency of capital is the percentage of profits e4pected from a given investment
on capital asset.
Diagram
The curve 1 shows the inverse relation between present value and rate of interest.
The rate of interest is on the horiEontal a4is and present value on vertical a4is.
!f the current rate of interest is i<, then the present value of the pro6ect is <.
!f the rate leads to higher end i=, then the present value will be lower to =.
#hen the present value curve 1 cuts at horiEontal a4is at the point )L* then the net
present value becomes Eero.
To find the worth purchase of capital good compares the present value of capital assets
with cost )or* supply price.
!f the present value e4ceeds the cost of buying then it is worth to buy. !f the present value
is less than its cost then it is not worth buying.
0e$nes prospecti#e #iew in the $iel+ of capital asset
+p 7 )1<:)<Mi** M )1=:)<Mi*N=* MOOM )1n:)<Mi*Nn*
+p 7 supply price
1<, 1= O.1n 7 rospective yields )From its life time*.
FgG !f the supply price of new capital asset is 1s <AAA:/ and if life is = years, it is e4pected to
yield 1s @@A:/ and 1s BA@:/ in the respective years. !ts MFC is <AH e,uates the supply price.
Then 1s <AAA 7 )@@A: )<M<AH** M )BA@:)<M<AH*N=
7 )@@A: )<.<A** M )BA@: )<.<A* N= 7 @AAM@AA
Marginal efficienc$ of in#estment %MEI&
This is the rate of return e4pected from a given investment on a capital asset after
covering all its cost. )F4cept the rate of interest*
The investment on asset depends on the interest rate in getting funds
!nterest rate !nvestment
!f high low
'ate of interest
Diagram
!f the rate interest is or< then the investment is at %!3. #hen the rate of interest falls to
%1= then the investment will be %!
-ere interest rate is on vertical a4is and investment on horiEontal a4is. MF! and MF! are
investment demand curves.
!n panel ( MF! curve investment is less elastic and in panel $ MF! curve investment is
elastic.
1istinction -etween MEC 2 MEI
MEC MEI
$ased on the given supply price for
capital
!nducted changes in the price
+hows rate of return on all successive
units capital without giving importance
to capital
This shows the rate of return on units of
capital above the e4isting capital
Capital stoc" is ta"en on the horiEontal
a4is of the diagram
(mount of investment is ta"en
horiEontally on the a4is
This is stoc" concept This is flow concept
This determines optimum capital stoc"
in the economy at each level rate of
interest.
This determines net investment of the
economy at each interest rate given in
the capital stoc"
MULTIPLIER
Concept of multipler:
This was first developed by 1.F. "ahn in <P>< and 'eynes formulated investment multiplier.
Meaning:-
This is an integrated in the theory of employment framed by 'eynes
According to him this establishes a precise relationship, given the propensity to consume,
between aggregate employment and income and the rate of investment
#hen there is an increment of investment, income will increase by an amount which is ' times
on the increment of investment.
;8 7 ';!
' 7 ;8:;!
#here 8 is income, ! is investment, ; is the change )increment or decrement* ' is the
multiplier.
This ' refers to the power by which any initial investment is multiplied to obtain a final
increase in income.
The value is determined by the marginal propensity to consume
;8 7 ;C M ;! )or*
;8 7 C;8 M ;!
;8 I C;8 7 ;!
;8 )</C* 7 ;!
;8 7 ;!: )</C*
);8:;!* 7 <: )</C*
'7 !: )</c* therefore '7);8:;!*
This multiplier can also be derived from M+ #here ' 7 )<:M+*
3or4ing of the multiplier:
'oun+ 5I %increment
in
in#estment&
5)
%increment in
income&
5C 6 C 5)
C 6 789
5S%5).5C&
%increment in
sa#ing&
< <AA <AA @A @A
= @A =@ =@
> =@ <=.@A <=.@A
? <=.@A B.=@ B.=@
@ B.=@ >.<= >.<=
B >.<= <.@B <.@B
C <.@B A A
A A
<AA =AA <AA <AA
!f the investment is raised by 1s <AAcrores .it will lead to a rise in production and income
by 1+ <AA crores.
Q of the new income will be immediately spent on consumption goods which will lead to
a rise in production and income by the same amount
The @A crore saved will increase income by same amount in the second round.
!n this process the income generated will go up to the limit till the investment rises up to
1s =AA crores.
ssumptions of multiplier:.
This 'eynes theory of multiplier wor"s under certain assumptions. They are
Change in autonomous investment and inducted investment is absent.
The marginal propensity to consume is constant
Consumption is a function at current rate.
There is no time lag in multiplier process.
The new level of investment is maintained steadily.
There is surplus capacity in consumer goods to meet the increased demand
followed by a raise in increased investment.
There are no changes in prices.
Multiplier process operates in an industrialiEed economy.
:USINESS C)C(ES
Meaning:
This is the phenomenon of cyclical booms and depression.
This wave li"e fluctuations happens 6ust because of aggregate employment, income, and
output and price level.
'eynes defines as a trade cycle is composed of periods of good trade characteriesed by
rising prices and low unemployment percentage, altering with periods of bad trade
characteriEed by falling prices and high unemployment percentage
*eatures of -usiness c$cles:.
These cyclical fluctuations are of wave li"e movement
Fluctuations are recurrent in nature.
They are non/period. $oth pea" J trough do not occur at regular intervals.