Consumption, Savings and

Investment
Consumption function
Savings
The Multiplier

Autonomous consumption
Autonomous consumption expenditure C A
occurs when income levels are zero. Such
consumption does not vary with changes in
income.
If income levels are actually zero, this
consumption is financed by borrowing or
using up savings.

Induced consumption
Induced consumption CI describes
consumption expenditure by households on
goods and services which varies with
income.
Consumption is considered induced by
income.

Marginal Propensity to
Consume
The marginal propensity to consume
(MPC) is the extra amount that people
consume when they receive an extra unit of
income.
MPC = C / Y
MPC is the first derivation of consumption
function.

Induced consumption can be described by

formula:
CI = MPC . Y

The Consumption Function

The consumption function shows the
relationship between the level of
consumption expenditure and the level of
income.
C = f (Y)
If autonomous and induced consumption is
identified then: C = CA + CI
C = CA + MPC . Y

The Consumption Function

C
Savings
Consumption
function C = f(Y)
CA

Consumption
45

Y1

Y2

The Consumption Function

45 line: at any point on the 45line
consumption exactly equals income and the
households have zero saving.
MPC is the slope of the consumption
function, which measures the change in
consumption per unit change in income.

Savings
Saving is that part of income that is not
consumed. Saving equals income minus
consumption: S = Y C
Income is the sum of consumption and
savings: Y = C + S
then

C S
1
Y Y

and

C S

1
Y Y

Savings
The marginal propensity to save
S
MPS
Y

is defined as the fraction of an extra unit of

income that goes to extra saving.
MPC + MPS = 1 because the part of each
unit of income that is not consumed is
necessarily saved.

Saving Function
Like consumption saving is also the function
of income: S = f(Y)
If autonomous consumption exists then
autonomous saving exists as well and saving
function is: S = -CA + MPS.Y
Saving is a source for investment.

The Consumption and Saving

Function
C, S

C = f(Y)

S = f(Y)

CA
0
-C

45
YE

The saving
function is the
mirror image of
the consumption
function. It shows
the relationship
between the level
of saving and
income.

The Simple Theory of

Investment
In the simple Keynesian model,
investment is independent of national
income (autonomous investment).
The investment function will be a
horizontal straight line.

The Investment Function

I

I2
I1

I2

In the short-run it
is reasonable to
assume that
investment is
independent of
national income.

I1

Consumption and Investment

Functions
The spending curve shows the level of
desired expenditure by consumers (CA +
MPC.Y) and businesses (I) corresponding
to each level of output.

Consumption and Investment

Functions
C, I
C + I = CA + MPC . Y + I
C = CA + MPC . Y
I
I
0

Consumption and Investment

Determine Output
If the level of output is e. g. Y1 at this level
of output the C+I spending line is above
45line, so planned spending is greater than
planned output.
This means that consumers would be
buying more goods than the businesses
were producing. Thus spending
disequilibrium leads to a change in output.

Equilibrium National Income

C, I
C + I = CA + MPC . Y + I
E

Consumption and
investment determine
output

45

Y1

YE

Y2

Saving and Investment

Determine Output
Equilibrium occurs when desired saving of
households equals the desired investment of
businesses.
When desired saving and desired
investment are not equal, output will tent to
adjust up or down.

Saving and Investment

Determine Output
S, I

S = f (Y)
E

0
Y1
-

YE

Y2

Saving and Investment

Determine Output
At output level Y2 families are saving more
than businesses are willing to go on
investing. Firms will have too few
customers and large inventories of unsold
goods than they want. Then, businesses
will cut back production and lay off
workers. This move output gradually
downward and economy returns to
equilibrium YE.

Investment Multiplier
The Keynesian investment multiplier model
shows that an increase in investment will
increase output by a multiplied amount by
an amount greater than itself.
The multiplier is the number by which the
change in investment must be multiplied
in order to determine the resulting change
in total output.

Investment Multiplier
C + I2

C, I

I2 = I1 + I

E2
C +I1

Y = k . I

E1

Y
k
I

I
45

Y1 Y

Y2

Investment Multiplier
S
S = f (Y)
E2
I

E1

0
-

Y1 Y Y2

I2
I1
Y

Investment Multiplier
The size of the multiplier k depends upon how
large the MPC is.
Y
Y
1
1
1
k

I Y C 1 C 1 MPC MPS
Y