CONSUMPTION FUNCTION & INVESTMENT FUNCTION UNIT - 11 CONSUMPTION FUNCTION & INVESTMENT FUNCTION

CONSUMPTION FUNCTION Consumption refers to a particular amount of consumption out of a given amount of income. Consumption function indicates the relationship between consumption and income. Consumption function refers to different amounts of consumption at different level of income. C = f (Y)

PSYCHOLOGICAL LAW OF CONSUMPTION According to the law, “when aggregate income increases, consumption expenditure shall also increase but by a somewhat smaller amount.”

THE AVERAGE PROPENSITY TO CONSUME TOTAL CONSUMPTION APC = TOTAL INCOME THE MARGINAL PROPENSITY TO CONSUME It is the incremental change in consumption as a result of a given increment in income. It is the ratio of the change in aggregate consumption to the change in the level of aggregate income.

CHARACTERISTICS OF MPC : Value is always positive but less than 1. MPC is greater than 0. It goes down as income increases. MPC of the poor is greater than that of the rich.

RELATIONSHIP BETWEEN MPC & APC INCOME CONSUMPTION APC MPC 100 100 100% - 200 180 90% 80% 300 240 80% 60% 400 280 70% 40% 500 300 60% 20%

INVESTMENT FUNCTION TYPES OF INVESTMENTS: Investment is the creation of income – earning assets. TYPES OF INVESTMENTS: Private Investment Public Investment Foreign Investment Induced Investment Autonomous Investment

SOME OTHER KINDS OF INVESTMENTS: GROSS INVESTMENT REPLACEMENT INVESTMENT NET INVESTMENT Ex – ANTE INVESTMENT Ex – POST INVESTMENT

MARGINAL EFFICIENCY OF CAPITAL It may be defined as the highest rate of return over cost accruing from an additional unit of capital asset. Prospective yield from the capital assets. Supply price (cost of capital assets) Q1 Q2 Q3 Qn Cr = + + + ……………… + (1+r) (1+r) (1+r) (1+r) n 1 2 3

DETERMINANTS OF MEC : SHORT – RUN FACTORS: Cost & Price Higher propensity to consume Current rate of expectation Changes in income State of business confidence

LONG – RUN FACTORS: Rate of growth of population Development of new areas Technological progress Productive capacity of existing capital equipments Rate of current investment

MULTIPLIER It is defined as ratio of change in income to a change in investment. Multiplier is a number which gives a multiple increase in national income due a given increase in investment, i.e. I CHANGE IN INCOME K = CHANGE IN INVESTMENT 1 K = 1 - MPC

ASSUMPTIONS AND LIMITATIONS OF THE MULTIPLIER : Availability of consumer goods. Maintenance of Investments. Net increase in Investments. No change in the size of MPC. No time gap between successive expenditure on consumption. Existence of closed economy. It is based on number of assumptions.

LEAKAGES : Savings Accumulation of idle cash balance. Debt cancellations. Purchase of old shares and stocks. Imports. Taxes. Corporate savings.

ACCELERATOR ∆ I A = --------------------- ∆ C