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Income Determination – Concept of Consumption and Its Relationship With Savings and Investment

Consumption is the total quantity of goods and services purchased and used by consumers during a specified period of time. Consumption is also described as expenditure on goods and services at a given period of time. It is the expression of total consumer demand. Types of consumption includes: durable goods, non-durable goods and services. Durable goods involves consumption expenditure on certain items which are durable in nature eg, houses, vehicles, furniture, machines etc, non-durable goods involves consumption expenditure on goods that are not durable in nature, eg, food, clothing, water etc. Services involves consumption expenditure on general services, eg, legal fees, medical fees, entertainment fees, educational fees etc.

Factors which determine the level of Consumption are:
1. Savings: The level of savings influences consumption. High savings influences consumption and tends to reduce the level of consumption.
2. Level of income: The higher the income, the higher the level of consumption.
3. Availability of credit facilities: Availability of credit facilities either to individuals or firms tends to increase the level of consumption.
4. Income distribution; Equitable distribution of national income will increase the disposable income of individuals thereby increasing the level of consumption.
5. Possession of assets: Revenue generated by assets increases the income of their owners and this tends to raise the level of consumption.
6. Rate of taxation: High taxation reduces the income of people and this reduces the level of consumption.
7. Interest rate; If the interest rate received is high, it will generally increase the income leading to a rise in the level of consumption.
8. Profit earned: High profits earned either by individuals or firms increase income thereby resulting in a rise in the level of consumption.
9. Future expectation: expectation of rise in the prices of goods and services will elad to a rise in the level of consumption expenditure and vice versa.

Relationship between savings, Investment and Consumption
Savings, investment and consumption are closely related. We save in order to accumulate capital for investment and for many other personal reasons. There will be no investment without savings. Investment, in turn, creates employment and income for people. Without it and, therefore, without income, we shall have nothing to save and nothing to spend on consumer goods and services.

What we do not spend is what is saved. Consumption, therefore, is affected by decisions to spend. If we spend all our income, there will be no capital accumulation for investment. Therefore, the community’s income is made up of savings, investment and consumption. Savings, investment and consumption are related to income with the use of the following formula:
Y= C + S
Y= C + I
S= I; where Y is income, C is consumption expenditure and I is investment expenditure.

Propensities to Consume
Propensities to consume can be in two groupings:

I. Average propensity to consume (APC): The APC is defined as the proportion of the national income that is consumed. In order to calculate APC, the total national consumption is divided by the total national income. The formula is:
APC= Total National Consumption/Total National income = C/Y.

For example, the total national income for Belarus is $20 million and the total national consumption is $5 million, to find the APC, it will be $5m/$20m = 0.4

II. Marginal propensity to consume (MPC)
The MPC is defined as the relationship between changes in income and changes in consumption. It shows the extent to which the level of consumption changes as a result of a change in income. It, therefore, shows the proportion of any addition to income, which is used for consumption.
MPC = changes in consumption/Changes in income = dC/dY

For example, if the monthly income of an individual increases from $10,000 to $15,000 and increases his level of consumption from $4,000 to $6,000, his marginal propensity to consume can be calculated as follows:
initial income per month= $10,000
New income per month= $15,000
Changes in income (dY) = $15,000-$10,000= $5,000
Initial consumption per month= $4,000
New consumption per month= $6,000
Changes in consumption (dC)= $6,000-$4,000= $2,000.
MPC= dC/dY= $2,000/$5,000= 0.4 This is low and hence good for his savings and financial growth.

Propensity to save
This is also in two groupings

Average propensity to save : The average propensity to save is defined as a measure of the proportion of income which is saved (not spent on consumption). It shows the expected amount of savings at different levels of income.

APS= Total National Savings/Total National Income = S/Y
The APS increases with increasing income. As the level of income increases, one is able to save more money.
Note that APC + APS = 1.

For example, if Makama Incorporation firm earns $80 billion and spent $50 billion on procurement of working materials, the APS of the firm would be;
Total income= $80 billion
Total expenditure= $50 billion
Total savings = Total income – Total expenditure = $80 billion – $50 billion = $30 billion
Therefore, APS = Total savings/total income = $30 billion/$80 billion = 0.38

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