Here students are introduced to the concepts of consumption and its

determinants. It explains in general form, what consumption expenditure

involves and clearly differentiates consumption function from saving function and the derivation of former from the latter.

This unit also introduce the students to the algebraic derivation of saving

function from consumption function and vice versa. It also explained the

determining factors of saving and it shows relationship between saving and

investment.

At the end of this unit, the student should be able to;

i. Recognize both saving and consumption functions.

ii. Derive saving function from consumption function

iii. Derive consumption function from a given saving function.

iv. Determine those factors that influence consumption expenditures.

v. Identify those factors that determine saving.

vi. Understand the relationship between saving and investment

### Derivation of consumption and saving function.

Derivation of Consumption Function from a given Saving Function

Given a saving function S = -Î± + sYd ; to derive consumption function we will

reflect on the classical assumptions and model that;

Y = C + S ……………………………………….1 or

Y d = C + S………………………………………..2 considering the equation (2)

C = Yd – S but S = -Î± + sYd ……………………..3

Therefore, C = Yd – (-Î± + sYd) ………………… 4

C = Yd + Î± - sYd …………………………………5

Collect like terms;

C = Î± + Yd – sYd ..................................................6

C = Î± + (1 - s) Yd…………………………………7

Recall that 1- s = 1 – MPS = MPC = b; therefore,

C = Î± + b Yd …………………………………….8 QED

Numerical Example

Given the following saving function S = - 25 + 0.3Yd, derive the consumption

function.

Since Yd = C + S

Therefore, C = Yd – S

C = Yd – (-25 + 0.3Yd)

C = Yd +25 – 0.3Yd

Collect like terms:

C = 25 + (1 – 0.3)Yd

C = 25 + 0.7Yd

### Derivation of Saving Function from a Consumption Function

Mathematically the saving function can also be derived from the consumption

functions

S = Y – C

Since C = a + by

Therefore;

S = Y – (a + bY)

S = Y – a – bY

S = -a + Y – bY

S = -a + (1 – b) Y

If 1 – b = Î²

Then

S = -a + Î²Y

Numerical example;

Given a consumption function C = 25 + 0.75Yd

Recall that S = Y – C ………………………………..(1)

Therefore; S = Y – (25 + 0.75Yd) …………………….(2)

S = Y – 25 – 0.75Yd ………………………..(3);

Let Y = Yd………………………………………(4)

Therefore equation 3 becomes;

S = Y – 25 – 0.75Y……………………………...(5)

Collect like terms from eqn. 5 above, to have,

S = -25 + Y - 0.75Y …………………………….(6)

Factor out Y in eqn. 6 above, to have;

S = -25 + (1 – 0.75)Y ……………………………(7) S

= -25 + 0.25Y ………………………………….(8) The equation (8) above is the required saving function.

Self Assessment Exercise

i. Differentiate between bY and b from the above analysis

ii. Differentiate between b and 1 - b

iii. Clearly explain saving concept and derive saving function from a

hypothetical schedule.

### Determinants of aggregate saving and consumption expenditure

There are a number of factors that determine or influence household level of

consumption. These include, among others, the following;

i) The level of disposable income

ii) Stock of durable goods on hand

iii) Wealth

iv) Expectations

v) Total household indebtedness

vi) The price level

vii) Government fiscal policy

i. The level of disposable income: The level of income is the basic determinant of how much households will consume. An increase in disposable income will increase consumption expenditure and vice versa.

ii. Stock of durable goods on hand: In an economy, the stock of durable

goods on hand determines the amount of current consumption. If

consumers in an economy find themselves well supplied with various

durable goods, e.g. cars, television, etc. all worthy of years of service than

the current level of consumption may fall. This is because many

households will be out of the market for such products with the result that

consumers will be willing to spend less at each level of disposable income

iii. Wealth: This refers to the stock of accumulated purchasing power stored

up from the past. For example, savings done in the past can be used to finance

current consumption. The higher an economy‘s wealth, all other things being

equal the higher will be current consumption.

iv. Expectations: Household‘s anticipation regarding future prices of goods,

their nominal income and the availability of goods may have an impact on

their current spending. Anticipation of rising prices and product shortages

tend to cause more spending.

v. Total household indebtedness: Debts are paid with current income. If in

an economy total household debts are huge there is the likelihood that current

level of consumption expenditure will be low and vice versa

vi. Level of prices: In an economy, the higher the level of prices the lower

the volume of real consumption expenditure

vii. Government fiscal policy: Fiscal policy in its simplest form implies

government spending and means through which revenue are generated

(taxes). However, if taxes are raised, disposable income will reduce and by

implication consumption will also reduce and vice versa.

### Determinants of Saving

The determinants of saving are replica of those of factors that determine

consumption except in some few cases.

i. The level of disposable income: The level of income is the basic determinant

of how much households will consume or save. An increase in disposable

income will increase consumption expenditure and vice versa.

ii. Stock of durable goods on hand: In an economy, the stock of durable goods

on hand determines the amount of current consumption. If consumers in an

economy find themselves well supplied with various durable goods, e.g. cars,

television, etc. all worthy of years of service than the current level of

consumption may fall. This is because many households will be out of the

market for such products with the result that consumers will be willing to spend

less and save more at each level of disposable income.

iii. Wealth: This refers to the stock of accumulated purchasing power stored up

from the past. For example, savings done in the past, the higher this wealth the

lower is the willingness to save further and vice versa.

iv. Inflation Expectations: Household‘s anticipation regarding future prices of

goods, their nominal income and the availability of goods may have an impact on

their current saving. Anticipation of rising prices and product shortages tend to

cause less saving.

v. Total household indebtedness: Debts are paid with current income. If in an

economy total household debts are huge there is the likelihood that current level

of saving will be low and vice versa

vi. Level of prices: In an economy, the higher the level of prices the lower the

volume of saving.

vii. Interest rate: The higher the money market rate of interest the higher would

be the level of saving, because current consumption could be postpone for more

wealth.

viii. Return on investment: The higher the return on investment the lower will

be saving level and vice versa.

ix. Government Fiscal Policy: The direction of fiscal policy to a great extend

has impact on current saving, for instance contractionary fiscal policy will reduce

disposable income and as a result reduce saving.

Self Assessment Exercise

i. List and explain various determinants of consumption expenditure.

### Relationship between Consumption and Saving

The main relationship between saving and consumption is that the income level

is shared between the two. Every level of income is either saved or consumed,

so income is the major factor that influences the both of them.

Algebraically, C= f(Y) and also S = f(Y)

i.e. Y= C + S therefore; C = Y – S while also S = Y – C

Saving is always equal to income less consumption and consumption is also

always equal income less saving..

Self Assessment Exercise

i. Show the relationship between consumption and saving

### CONCLUSION

We explained various determinants of consumption expenditure as well as

algebraic derivation of consumption expenditure from a given saving function

and conclude that income is a major determinant of consumption expenditure.

This unit also concludes that saving function could be derived from a given

consumption function and vice versa. We equally conclude that all things being

equal other than income level there are numbers of factors that influence the

aggregate level of saving.

### SUMMARY

This unit looked at concept of consumption and its determining factors, it also

expresses consumption, numerically (function). We also, derive consumption

function from a given savings function and explain the marginal propensity to

consume.

It also looked at concept of saving and its determining factors, it also expresses

Saving, algebraically (function). We also, derive savings function from a given

consumption function and explain the marginal propensity to save.

### TUTOR MARKED ASSIGNMENT

i. Define consumption

ii. List and explain components of consumption function

iii. Given that S = -25 + 0.6Yd derive the consumption function and

illustrate the result on a curve.

iv. Define Saving

v. List and explain components of Saving function

vi. Given that C = 5 + 2/3Yd derive the Saving function and illustrate

the result on a curve.

vii. Differentiate between saving function and curve.

### REFERENCES

Attah B.O, Bakare, T.A. & Daisi, O.R., (2011); Anatomy of Economics

Principles, Q&A (Macroeconomics), Raamson Printing Press, Oke-Afa, Isolo,

Lagos, Nigeria

Amacher, R and Ulbrich, H, (1986); Principles of Economics, South Western

Publications Co. Cincinnafi, Oliso

Bakare –Aremu T.A, (2013); Fundamental of Economics Principles

(Macroeconomics), Raamson Printing Press, Oke-Afa, Isolo, Lagos, Nigeria

Bakare I.A.O, Daisi, O.R., Jenrola, O.A., & Okunnu, M.A., (1999): Principles

and Practice of Economics (Macro Approach), Raamson Printing Press,

Mushin, Lagos, NigeriaDennis R. A. et-al; International Economics, Mcgraw

Hill Irwin, 8thedition.

Familoni K.A, (1990); Development in Macroeconomics Policy, Concept

Publications, Lagos, Nigeria

Fashina E.O, (2000); Foundations of Economics Analysis (Macro Theories),

F.E.F International Company, Ikeja, Lagos, Nigeria

Jhingan M.L, (2010); Macroeconomics Theory, 12th edition, Vrinda

Publications (P) Ltd. Delhi, India

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