Consumption Function
- Hi. Let's talk about aggregate expenditure. This is saying, how much do we consume? So first we're going to do is what we call the consumption function. The first thing that you'll notice about this is, is that it's very fun to say-- consumption function (CHUCKLES). All right, so our consumption function is a relationship between our disposable income and our consumption. So here it's saying, how much do we consume? Well, what we're first going to assume is that we consume something no matter what.
So even if we have zero disposable income, I still want to eat. So here I might consume $20 a month. So this would be here at 20. We call that autonomous consumption. Again, this consumption that I engage in, no matter what my income, is called autonomous consumption, because it doesn't depend on my income. Now here, if we start with an autonomous consumption of 20, I then might consume some amount for every additional dollar that I earn. So here, say I spend an additional $0.90 for every dollar.
So if I spend $0.90 of every dollar, we might say consume $0.90 of every additional dollar that I earn. That's going to be a marginal propensity to consume of 0.9. And this is saying I consume 90% of every additional dollar. Recall that marginal means additional. So here we're saying that for every additional dollar that I earn, I'm going to consume 90% of it. In this case, $0.90.
So here, what this means is that if I earn, say 100, so say YD equals 100. Well then, how much am I consuming? It's going to be 100 times 0.9, giving me 90, plus I'm already consuming this additional 20. So that means that when my income is 100, my consumption is going to be 110. So here I'm going have a straight line like this. This is consumption. If this is how much I'm consuming, what I might ask is at what point do I stop having to borrow? Well, notice I was borrowing in the first place, because I was not earning any income, but I was still consuming.
So that means I must have been borrowing. So at what point do I stop borrowing? That would be when consumption is equal to my income. So here if my consumption and income are equal, that means I'm not borrowing and I'm not saving. So that would be when consumption is, say, 10, and income is 10. When consumption is 20, and income is 20. So here it's going to give me some straight line.
Imagine that this is a straight line. This is the line consumption equals disposable income, which means that I'm consuming exactly what I earn. So here, consumption equals YD, that's just the 45 degree line. So here we have the 45 degree line. When these two intersect, that means that my consumption and income will be equal.
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