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

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