# THE CONCEPT OF CONSUMPTION AND SAVINGS CONTENTS

Here students are introduced to the concepts of consumption and its
determinants. The section explains in general form, what consumption
expenditure involves and clearly differentiates consumption function from
saving function and the derivation of the former from the latter. This unit
essentially explains consumption function, graph and its determinant with
special reference to calculations and derivations.
Also, students are introduced to the concepts of Saving and its determinants, it explains in general form, what saving involve and clearly differentiates saving
function from saving curve and the derivation of saving function from a given
Consumption function. This essentially explains saving function, graph and its
determinant with special reference to calculations and derivations.

At the end of this module the student should be able to;
i. Understand the concepts of consumption and saving
ii. Identify and explain both consumption and saving functions
iii. Derive consumption function from a given saving function.
iv. Determine those factors that influence consumption expenditures.
v. Determine those factors that influence saving function
vi. Understand the relationship among saving, consumption and investment

### Concept of Consumption And Saving

Planned consumption expenditure (C) is made up of planned expenditure by
households on durable and non-durable goods and services, for example,
household expenditure on plantain, cars, shoes, etc.
It should be noted that consumption is largely influenced by level of income
among other thing. Based on this fact, the consumption function was established.
The consumption function is a algebraic or functional relationship between
consumption expenditure by household and the level of disposable income of
individual household. Mathematically, consumption is expressed as a function of disposable income. i.e. C = F(Yd). Disposable Income is the personal income (Y) less personal Income tax (T) i.e. Yd = Y – T. In the absence of government, it is
expected that disposable income be equals gross income which is represented by (Y), in such case consumption will be a function of gross income and not net
income(disposable income) as explained above. Then it is written algebraically
and implicitly as C = f(Y) and explicitly as C = a + bY
Saving on the other hand can be defined as part or fraction of disposable income
kept aside in the national banking system for either future use or to generate
additional wealth (interest). Therefore, saving is said to be function of income
(i.e. S=f(Yd)), meaning that amount to be saved depend on the net income of
every individual. It is noteworthy that the word saving is conceptually different
from savings, while the former imply the ‗act‘ of keeping money, the latter imply
collections of the wealth been kept for a given period of time. Saving in
aggregate term is the total amount saved by all individual household in the
economy. It is a linear summation of all household saving in a country.
Algebraically, S = f(Y); S = Y – C
Meaning that, income saved, is current income not consume.

Self Assessment Exercise
i. Clearly explain saving concept.
ii. Explain the concept of consumption.

### The Consumption and Saving Functions

#### The consumption Function

Consumption Function- It is the functional relationship between consumption
expenditure and disposable income. It can also be described as a mathematical
expression of household spending in relation to its level of income. Disposal
income is gross personal income less personal income tax. For the simplest
consumption function, there are two arguments namely, the non income induced
consumption (also called autonomous consumption) and income induced
consumption (i.e fraction of disposable Income desired to consume), disposable
income is the main determinant of the level of consumption
This consumption function is given by;
C = a + bYd a > 0; 0 < b < 1
Where C = consumption expenditure and Yd = disposable income
The consumption function in this form is a linear function (a straight line) and it
is interpreted as follows:
“a” measures consumption expenditure when income is zero (0). This is called
autonomous consumption. It is independent of the level of disposable income (i.e. transfer payments). It is the intercept of the consumption function.
“bY” is income induced consumption expenditure. This is the proportion of
consumption expenditure that depends on level of disposable income.
“b” this is the slope of the function, it otherwise known as marginal propensity
to consume(MPC), that is fraction of disposable income consumed at a particular period in time, this is affected or influenced by many factors. It should be noted that MPC is always less than unity but greater than zero, the sum of MPC and marginal propensity to save (MPS) is unity.

From the above diagram, the positively sloped curve represents the consumption
curve, meaning that household consumption expenditure is positively related to the level of income i.e. the higher the level of income, the higher the household consumption level and vice versa. The letter ‗a‘ represents the consumption level not related to household level of income; it is always above the origin. On the
other hand the letter ‗b‘ represents the slope which is the marginal propensity to
consume (MPC). It simply implies a change in consumption level as a result of a change in level of household disposable income

#### The Saving Function and Curve

The saving function is a mathematical expression of saving and its primary
determinant. It is given below as;
S = f (Y) ………………………. (1)
S = -a + (1-b) Yd ……………… (2) or
S = -a + (1-b)Y………………… (3)
The first function implies that saving depend on level of income, that is
individual saving ability depends on individual income and same applies to
aggregate.
The second function implies a situation in which saving depends on net income
otherwise known as disposable income i.e Yd = Y-T (gross income less personal
income tax), while the last being the third function implies a situation where T
= 0.
“-a” is the non income induced saving or autonomous saving, that is , saving at
zero level of disposal income (dis-saving). “(1-b)” is the marginal propensity to
save (MPS). “(1-b)Yd” is the income induced saving.

Figure 2.1.1b shows the saving function. The line labelled S = -a + (1-b) Yd is the
saving function. This function relates saving to the level of disposable income.

Self Assessment Exercise
i. In clear term, explain saving concept and derive saving function from
an hypothetical schedule
ii. Differentiate between consumption curve and function

### Relationship among Consumption, Saving. Investment and Income Level

Income has been theoretically established to be the major determinant of both
saving and consumption. From the classical school through Keynesian down to monetarist, there is agreement that consumption and saving are largely dependent on the level of income. That is any level of income earned could either
be saved or consumed or be shared in certain proportion which varies between
individuals and the economy. These proportions of income that could be saved or consumed are called or known as marginal propensity to save or marginal
propensity to consume respectively. In the light of the above explanation, it
could be deduced that any amount spent by any individual or economy depends
on his (its) net worth which is known in the literature as disposable income
(GDP). In the same vein, any amount saved by any individual or economy also
depend on his (its) net worth, invariably level of income dictates the individual
and aggregate level of both saving and consumption. That is, algebraically;
C = f(Y) and S = f(Y)
Then both saving and consumption are theoretically linked to level of income at
both individual and aggregate level in such a way that an increase in one will
mean a decrease in the other.
In the same vein, Saving, Consumption and Investment are jointly influenced by
the level of income, both on aggregate and individual household level. Saving is
primarily determined by level of income, same as consumption and investment.
These three variables are linked together through aggregate level of income or
household income on a microeconomic level.
The algebraic relationship can be explained as follows:
S = f(Y) ...............1
C = f(Y) ................2
I = f(Y) .................3 or I = f(r) ............4
Y = C + I ................5
Y = C + S .................6
From the above, equation 1 ... 3, imply that, saving, consumption and investment
are respectively a function of income, while equation 5 and 6, simply expressed
the fact that income earned is either consumed or invested, similarly, income
earned is either consumed or saved.

Self Assessment Exercise
i. Clearly show the relationship between saving, consumption and investment.
ii. Establish relationship among income, consumption and saving

### CONCLUSION

In this unit we conclude that consumption both on aggregate and individual level
are largely determined by the level of disposable income on individual term and
on aggregate income on macro or country wide. We also established that both
saving and consumption are invariably determined by the level of income among
others. It was also concluded here that both saving and consumption shared level
of income in no certain proportion.
Also the students are introduced to the concept of saving, explained the
similarities and dissimilarities between saving and consumption as well as
graphical illustration of the saving function..

### SUMMARY

This unit discussed the concept of consumption and established relationship
between consumption, savings and level of income .relates it to microeconomics
to bring a clearer picture between the two. It further gives relevant examples on
both macroeconomic and microeconomics concepts and finally discusses the basic tools of macroeconomics analysis with definitions and examples.
This unit equally looked at concept of saving and it determining factors, in
addition, it establishes relationship between saving, consumption and investment

### MARKED ASSIGNMENT

i. Clearly distinguish between consumption and savings concepts.
ii. Enumerate and explain various factors that could influence savings.
iii. Explain various factors that could influence consumption at a particular time
iv. Define consumption concept.
v. List and explain components of consumption function.

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