Consumption Theory

Consumption Theory

Definition of consumption:

·         Measurement on household spending on goods and services.

·         Consumption function shows relationship between consumption of households by disposable income an economy. 

C = a + bYd

Consumption function; => C= a + bYd

                                   

C = consumption

a = autonomous consumption

b = MPC

Yd = disposable income

Law of consumption; when income low, their consumption also low but when income high, consumption also high. Therefore, law of consumption has positive relationship.

Autonomous consumption

·    The minimum level of consumption that would still exist even if a consumer had absolutely no income.

Average propensity to consume (APC)

·         Average propensity to consume (APC) is the percentage of income spent. To find the percentage of income spent, we need to divide consumption by income

Formula:        APC = consumption (C )/ income(Y)

    Marginal propensity to consume (MPC)

·         Marginal propensity to consume is the relationship between a change in income and corresponding change in consumption.

Formula:        MPC = Change of consumption (∆C) / change of income (∆Y)

Determinants of consumptions

a.             Disposable income (Yd) @ income (Y)

In general, household consumption is depending in their disposable income. If disposable incomes increase, household consumption will increase too. This disposable income counted after tax deduction.

                       

b.            Interest rate and Loan Condition

When interest rate in the market was decrease, borrowing cost would become cheaper. As such, consumption spending in country would be higher. Consumption spending will also increase if loan condition charged by banks very loose.  So, the consumer easy to get the loan and it will increase the total consumptions.

c.             Government policies

Through fiscal policy, if governments reduce tax its will reduce commodity prices. So, the disposable income will increase and these further encourage total consumption. 

                                   

d.            Hire Purchase and Credit Facilities

If easy for someone to get debt facility, it can increase consumption. In this concept, society use concept “buys now and pays later". Example; credit card.

e.             The invention of new goods

The invention of new goods was coming into market to replace old commodities. For example color TV replacing black and white TV, the level of consumption is expected to rise.