Question

Look at the Keynesian consumption function: \(C=C_{0}+\left(M P C \times Y_{d}\right)\). What part of it relates to autonomous consumption? What part of it relates to induced consumption? Define autonomous consumption and induced consumption.

Short answer

In the Keynesian consumption function \(C=C_{0}+\left(M P C \times Y_{d}\right)\), autonomous consumption is represented by \(C_{0}\) and it is the level of consumption that occur even when income is zero. It refers to expenditure on essentials, independent of income levels. Induced consumption is represented by \(\left(M P C \times Y_{d}\right)\) and it changes with changes in income, referring to discretionary expenditures.

Step-by-step solution

Identify Autonomous Consumption

Autonomous consumption in the Keynesian consumption function \(C=C_{0}+\left(M P C \times Y_{d}\right)\) is represented by \(C_{0}\). It refers to the consumption expenditure that occurs when income levels are zero. In other words, even when people have no income, they will still consume something out of their personal savings or borrowings.

Define Autonomous Consumption

Autonomous consumption is the level of consumption that is not influenced by current income levels. This reflects the consumption that individuals and households must make to cover basic needs, like food and housing, regardless of their income.

Identify Induced Consumption

Induced consumption, in the Keynesian consumption function \(C=C_{0}+\left(M P C \times Y_{d}\right)\), is represented by \(\left(M P C \times Y_{d}\right)\). Here, \(MPC\) is the marginal propensity to consume, and \(Y_{d}\) is the disposable income. It shows that consumption varies with changes in disposable income.

Define Induced Consumption

Induced consumption is the portion of consumption that changes with income. In other words, as income increases or decreases, consumption also increases or decreases. This is primarily influenced by the individual's or household's discretionary expenditures, such as on entertainment, luxury goods, and other non-essential items.

Key concepts

Autonomous Consumption

Autonomous consumption refers to the part of total consumption that does not change with income levels. It is symbolized by \(C_{0}\) in the Keynesian consumption function, which is defined as \(C=C_{0}+ \left( MPC \times Y_{d} \right)\). This kind of consumption occurs even when income is zero because certain expenditures are essential for survival and maintaining a basic standard of living.

For instance, even when earnings are non-existent, individuals or households still need to spend on necessities like food, shelter, and clothing. They might rely on savings, loans, or assistance from others to finance these needs. Autonomous consumption underscores the basic expenses that are deemed unavoidable, irrespective of how much or how little someone earns.

Induced Consumption

Induced consumption is the portion of spending that varies directly with changes in income levels. In the Keynesian consumption function formula \(C=C_{0}+ \left( MPC \times Y_{d} \right)\), induced consumption is represented by \(\left( MPC \times Y_{d} \right)\). This indicates that beyond essential spending, the additional consumption is influenced by income variations.

When individuals or households experience an increase in income, they tend to spend more on non-essential items such as dining out, vacations, or luxury goods. Conversely, if income decreases, spending on these discretionary items often reduces. Induced consumption is flexible and reflects the economic behavior that adjusts in response to income changes. This showcases how significant a role income levels play in influencing spending patterns.

Marginal Propensity to Consume (MPC)

The marginal propensity to consume (MPC) is a critical component of the Keynesian consumption function. It measures the change in consumption resulting from a change in disposable income, expressed as a ratio. Essentially, MPC indicates how much more individuals are likely to spend from an additional dollar of income.

For example, if the MPC is 0.8, this means that for every extra dollar earned, 80 cents will be spent on consumption while the remaining 20 cents may be saved. An MPC value closer to 1 suggests that individuals spend most of their additional income, whereas a lower value indicates less spending and more saving. Understanding MPC helps economists and policymakers predict consumer spending behavior, especially in response to economic policies or shifts in income distribution.

Disposable Income

Disposable income refers to the net amount of money that individuals or households have available for spending and saving after accounting for taxes and mandatory expenses. In the context of the Keynesian consumption function, disposable income is represented by \(Y_{d}\).

This amount is crucial for understanding consumer behavior, as it determines the capacity to spend on both essential and non-essential items. The level of disposable income significantly impacts induced consumption, as outlined by the term \(\left( MPC \times Y_{d} \right)\). When disposable income increases, consumers generally have more flexibility to enhance their living standards by increasing their consumption.

Economists track changes in disposable income to assess economic health and forecast consumer trends. By analyzing disposable income, one can better predict shifts in demand for goods and services across different economic sectors.