1. CONSUMPTION FUNCTION & INVESTMENT FUNCTION
UNIT - 11
CONSUMPTION FUNCTION & INVESTMENT FUNCTION

2. 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)

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

4. 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.

5. 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.

6. RELATIONSHIP BETWEEN MPC & APC
INCOME CONSUMPTION APC MPC %
% %
% %
% %
% %

7. 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

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

9. 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)
Q Q Q Qn
Cr = ……………… +
(1+r) (1+r) (1+r) (1+r) n 1 2 3

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

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

12. 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

13. 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.

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

15. ACCELERATOR
∆ I
A =
∆ C