Consumption Function

Updated Jul 22, 2023

Definition of Consumption Function

The consumption function is an economic concept that describes the relationship between the total amount of disposable income and the total amount of consumer spending. In other words, it is a formula that shows how much people spend on goods and services, given their level of income.

Consumption Function Formula

The formula for consumption function is C = a + bY, where:

• C represents total consumer spending
• a is the autonomous spending, which is the amount of spending that occurs even when income is zero
• b is the marginal propensity to consume (MPC), which is the fraction of an additional dollar of income spent on consumption.
• Y is the total disposable income

Assumptions of Consumption Function

There are three major assumptions associated with the consumption function:

• Consumers prefer to maintain a stable standard of living over time, rather than a variable standard of living.
• Consumers have the knowledge and ability to adjust their spending habits based on their income levels.
• Consumers base their spending decisions on disposable income, not gross income. That is because they pay compulsory deductions like taxes and social contributions on gross income.

Implications of the Consumption Function

• When autonomous spending is high, the consumption function shifts upwards, indicating that people will spend more at all income levels.
• A higher marginal propensity to consume means that people will spend more of their income and save less. That, in turn, can stimulate economic activity and lead to the growth of businesses.
• The consumption function has important implications for government policies. By increasing autonomous spending through investments in infrastructure or social welfare programs, for example, governments can affect people’s spending habits and stimulate economic growth.