Keynesian Consumption Function

The consumption function is not only fun to say ("Consumption Junction, what's your function?")...it’s also a reflection of the relationship between a consumer’s income and spending levels.

An economist named Keynes (maybe you’ve heard of him) sat down and did a lot of thinking. One of the things he thought was that consumer spending depends on people’s income...particularly their disposable income. Disposable income is that “fun money” you have after you’ve paid all your bills and life necessities.

The more disposable income you have in your wallet, the more money you are likely to spend...right? Well, Keynes didn’t want to assume that the level of consumer spending would be constant (because that would be silly). Instead, he came up with another rate that determines the rate of the Keynesian consumption function, called the “marginal propensity to consume.” The more people who are spending out of their disposable income, the higher their marginal propensity to consume.

The consumption function is C = A + MD, which is consumer spending = autonomous spending (basic necessities, like food) + the marginal propensity to consume x real disposable income.

For instance, your spending would be $2,000 (C) if your food and rent and living expenses cost you $1,500 (A) and you spent 50% (M) of your $1,000 disposable income (D), or $2,000 = $1,500 + 0.5*$1,000.

Because this is economics, of course the consumption function is graphable, with consumer spending on the y-axis and disposable income on the x-axis. The marginal propensity to consume changes the slope, and economists typically assume that the slope gets less and less steep as it slopes upward and to the right, because people spend a smaller percentage of their disposable income when they have more of it.