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Chapter 10

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36 views5 pages

Chapter 10

Uploaded by

Clarisse Gomez
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10 EQUILIBRIUM LEVEL OF INCOME

INTENDED LEARNING OUTCOMES

By the end of the learning experience, students must be able to:

1. Understand the concept of the consumption and saving function;


2. Clearly discuss the relationship between consumption and saving in the level
of disposable income; and
3. Identify the simple income determination.

The Consumption and Savings Functions

Consumption is the part of income spent on goods and services yielding direct
satisfaction. It occupies the biggest chunk of the expenditure on output.

Y=C+S
Where Y = Income
C = Consumption
S = Saving

Consumption function is the relationship between consumption and income. All


things being equal, the amount of consumption depends on income. The higher the income,
the higher also is the consumption and vice versa.
Saving is the part of income that is not consumed. If the income equals the
consumption, there is no saving. When the income exceeds the consumption, the saving is
positive and when the income is less than the consumption, the saving is negative or there
is a dissaving.
Savings function is considered as the mirror image of the consumption function.
Given the definition that income, which is not consumed is saving function in a
mathematical equation as:
S=Y–C

Table 10.1. Consumption and Savings Schedule


Income (Y) Consumption Savings
1500 1785 -285
1700 1850 -150
1900 1900 0
2500 2400 100
3000 2700 300
3700 3200 500
Figure 10.1. Consumption and Savings Curves

Marginal Propensity to Consume (MPC)


- The concept of MPC was introduced by John Maynard Keynes to explain
how consumption can change. The term “marginal” to economists refers
to extra or additional, propensity means tendency.
- Additional tendency of an individual to consume when his disposable
income increases by 1 peso.
- Numerical measure of the slope of the consumption function that
measures the change in consumption per peso change in income.
∆C C2 − C1
MPC = =
∆Y Y2 − Y1

Average Propensity to Consume (APC)


- The proportion of income that is consumed.
C
APC =
Y

Marginal Propensity to Save (MPS)


- Fraction of income that is saved. It is the slope of savings function.
∆S S2 − S1
MPS = =
∆Y Y2 − Y1

Average Propensity to Save (APS)


- The proportion of income that is saved.
S
APS =
Y

Table 10.2. Marginal Propensity to Consume and Save


Income Consumption Saving APC MPC APS MPS
(Y)
1500 1785 -285 1.19 -0.19
0.325 0.675
1700 1850 -150 1.088 -0.088
0.25 0.75
1900 1900 0 1 0
0.833 0.167
2500 2400 100 0.96 0.04
0.6 0.4
3000 2700 300 0.9 0.1
0.714 0.286
3700 3200 500 0.865 0.135

The sum of MPC and MPS should be equal to 1. Because the fraction of any income
that is not consumed is saved, therefore the fraction consumed plus the fraction saved must
use up the whole change. Like MPC and MPS, the sum of APC and APS is also 1, because
disposable income itself is devoted to net consumption or saving. It then follows that the
two ratios C/Y and S/Y must add up to 1.

Investment and the Multiplier Effect

Additional
Employmen Increase
t Income

Increases
Additional Consumptio
Investmen n

Increase
Demand
Additional
Production

Figure 10.2. Circular Flow of Investment and Multiplier Effect

The concept of multiplier effect is related to accelerator effect. The effect of


consumption on investment is called the accelerator effect. More consumption encourages
the businessmen to increase production which opens the way for more employment. More
employment on the other hand stimulates more income which leads again to higher
consumption. This accelerates the economic growth.

Recall that the marginal propensity to save (MPS) is a fraction of a change in income
that is saved. It is defined as the change in S (ΔS) over the change in income (ΔY).

∆�
MPS =
∆�
Because ΔS must be equal to ΔI for equilibrium to be restored, we can substitute ΔI
for ΔS and solve:

∆�
MPS =
∆�
Therefore,
1
∆� = ∆� �
���

The change in equilibrium income ( ∆�) is equal to the initial change in planned
investment (∆�) times 1/MPS. The multiplier is 1/MPS.

1
Multiplier ≡
���
Because MPS + MPC ≡ 1, MPS ≡ 1 – MPC. It follows that the multiplier is equal to

1
Multiplier ≡
1 − ���
Paradox of Thrift
At equilibrium, saving equals investment. According to the classical economists, the
economic growth depends on capital formation. In order to accumulate capital, it is
necessary for society to save for investment funds. Hence, more savings is good because
more funds will be available for investment. However, according to John Maynard Keynes,
the attempt of consumers to save more will reduce savings. This is known as the paradox of
thrift.

REFERENCES

Bello, A.L., Bello, R.T., Camacho, Jr. J.D.V., Calete, M.A..O, Cuevas, A.C., & Rodriguez,
U.E. (2009). Economics. C & E Publishing, Inc: Quezon City: Philippines.

Gabay, B.K.G., Remotin, R.M. Jr.,Uy, E.A. M., and Uy, A.C.D. (2012). Economics Its
Concepts and Principles (with Agrarian Reform and Taxation). Rex Bookstore, Inc.:
Manila, Philippines

Case, K.E., Fair, R.C. and Oster, S.( 2009). Principles of Economics. (9th ed.) Pearson
Education, Inc.: USA

Fajardo, F.R. ( 2006). Economics (3rd ed). Rex Book Store, Inc.: Manila, Philippines

Mankiw, G. N. (1998). Principles of Macroeconomics. The Dryden Press, Harcourt Brace


College Publishers: USA
ACTIVITY 10
Equilibrium Level of Income

Name: ______________________________________ Score: _________________


Yr/Crs/Sec: __________________________________ Date: __________________

PROBLEM SOLVING. Given the household disposable income and consumption,


determine whether net saving or dissaving occur at each item and identify the amount.

Item Disposable Consumption Net Saving MPC APC MPS APS


Income or Dissaving
A 0 900
B 2500 3500
C 5300 5300
D 6000 5450
E 7500 5900

a. Compute for the net saving/dissaving, MPC, APC, APS and MPS.
b. Using the data above, plot the consumption function. Indicate disposable
income on the horizontal axis and consumption expenditure on the vertical axis.
Determine the break-even point.

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