Consumption function

Topic: Aggregate Demand, Income Determination and the Multiplier · NCERT: Class 12, Ch 4 "Determination of Income and Employment"

Meaning

The consumption function is the relation between how much households spend on consumption (C) and their income (Y): C = C̄ + cY. Here C̄ is autonomous consumption, the part that does not depend on income. cY is induced consumption, the part that rises with income. c is the marginal propensity to consume (MPC).

It matters because consumption is the largest part of aggregate demand (the total spending planned in the economy). In India, private consumption was about 60.9% of GDP in 2022-23 [4][5]. How people split their income between spending and saving decides how strongly income responds to new spending, which is the multiplier.

Explanation

Where it comes from and its two parts

• J.M. Keynes gave this idea in The General Theory of Employment, Interest and Money (1936), during the Great Depression.
• Demand had collapsed, factories stood idle and workers had no jobs.

• Keynes argued that total output depends on aggregate demand, and consumption is the biggest part of that demand.

• Household income is the main thing that decides how much people consume.

• Autonomous consumption (C̄)
• It does not depend on income and takes place even when income is zero.
• It is the subsistence level of spending, the bare minimum needed to survive: food and a roof.

• When income is zero, it is paid for by dissaving (using up past savings) or by borrowing.

• Induced consumption (cY)

• It depends on income and rises when income rises.
• Example: c = 0.8, Y = ₹1,000 → induced consumption = ₹800.

Marginal propensity to consume (MPC) and the graph

• MPC = ΔC/ΔY = c. It is the change in consumption for each ₹1 change in income. (Δ means "change in".)
• Range: 0 ≤ MPC ≤ 1. NCERT includes both end points.
• MPC = 0 → consumption does not change when income changes.
• 0 < MPC < 1 → the usual case. Part of the extra income is spent and the rest is saved.
• MPC = 1 → the whole extra income is spent.

• MPC can never be more than 1. Any spending beyond the extra income would come from past savings or loans, and that is not part of the marginal response to income.

• On a graph (income on the horizontal axis, consumption on the vertical axis):

• Intercept = C̄. The line starts above the origin, because people consume even at zero income.
• Slope = c = tan α. Because 0 < c < 1, the line is flatter than the 45° line.
• The 45° line shows every point where C = Y. Where the consumption line crosses it, saving = 0. This is the break-even point.

Worked example: Imagenia, C = 100 + 0.8Y

• At Y = 0, C = ₹100. So autonomous consumption = ₹100.
• Y = 1,000 → C = 900. Y = 1,100 → C = 980. So ΔC/ΔY = 80/100 = 0.8 (the MPC).
• ₹100 more income → ₹80 more consumption and ₹20 more saving.
• Break-even: 100 + 0.8Y = Y → 0.2Y = 100 → Y = ₹500.
• Below ₹500, C > Y, so households dissave.
• Above ₹500, C < Y, so households save.

The saving side and the average propensities

• Saving (S) = Y − C. Putting in the consumption function gives the saving function: S = −C̄ + (1 − c)Y.

• Imagenia: S = −100 + 0.2Y. The intercept is negative (−₹100 of pure dissaving at zero income).

• MPS (marginal propensity to save) = ΔS/ΔY = 1 − c, so MPC + MPS = 1.

• Each extra rupee is either spent or saved. In this simple model there is no third use.

• APC (average propensity to consume) = C/Y, and APS (average propensity to save) = S/Y.

• Since C + S = Y, APC + APS = 1 at every income level.

• APC = C̄/Y + c. So when C̄ > 0, APC > MPC at every income level.

• As income rises, C̄/Y shrinks, so APC falls towards MPC but never goes below it.
• MPC stays constant along a straight-line consumption function.

Y	C	S	APC	APS	MPC
0	100	−100	—	—	0.8
250	300	−50	1.20	−0.20	0.8
500	500	0	1.00	0	0.8
1,000	900	100	0.90	0.10	0.8
2,000	1,700	300	0.85	0.15	0.8

• At low income, APC can be more than 1 and APS can be negative, because households are dissaving. MPC still cannot exceed 1.

What shifts it, and the link to the multiplier

• Taxes: with a government, people consume out of disposable income (Yd), the income they actually have in hand after taxes and transfers. Yd = Y − T (+ transfers), so C = C̄ + c(Y − T).
• Imagenia, Y = 1,000: T = 0 → C = 900. T = 100 → C = 100 + 0.8 × 900 = 820.

• A ₹100 tax cuts consumption by only ₹80 (= c × ΔT). The other ₹20 comes out of saving.

• Fear and crisis: C̄ and c are not fixed for ever. Lockdowns and fear can shift the whole line down.

• Multiplier = 1/(1 − c) = 1/s.
• Imagenia: 1/(1 − 0.8) = 5. So ₹100 of new investment finally raises income by ₹500.
• Higher MPC → bigger multiplier, because more of each round of income is spent again.

In India

• Measure used: India tracks household consumption through private final consumption expenditure (PFCE) in the national accounts.
• PFCE is spending by resident households and non-profit institutions serving households (NPISH) on final goods and services, whether bought inside or outside the country [7].
• It includes imputed rent of owner-occupied dwellings (the rent people "pay themselves" for living in their own house) and home-grown produce that people eat themselves [7].
• Households and NPISH are estimated together, not shown separately [7].

• Method: the commodity flow approach. Start from the total supply of each good, then subtract its other uses, such as industry inputs, government use, capital formation, stocks and net exports [7].

• Who publishes it: MoSPI's National Accounts Statistics – 2025 (released 16 May 2025) gives consumption and saving estimates for households, the corporate sector and government. It follows the UN System of National Accounts (SNA), with base year 2011-12 [8].

• Size: PFCE was 61.0% of GDP in 2021-22 and 60.9% in 2022-23 at current prices [4][5]. That is about ₹6 of every ₹10 of GDP. It was 55.8% in 2005-06 [9].
• Latest growth: PFCE was estimated to grow 7.6% in 2024-25, up from 5.6% in 2023-24 [6].
• The saving side (gross savings shares, 2022-23) [4][5]:
• Households 60.9% (the largest saver), non-financial corporations 37.3%, financial corporations 9.3%.

• General government (−) 7.5%. The government dissaved: it spent more on current needs than its current income.

• Household saving in 2006-07 (% of GDP at current market prices) [9]: financial saving 11.8%, saving in physical assets such as houses and gold 12.5%, total 23.8%.

• COVID-19, a live example of the function shifting down:
• Household financial savings spiked in Q1 of 2020-21, against the usual seasonal pattern.
• The likely cause was forced saving: people could not spend on non-essentials during the lockdown [3].
• The rate then eased to 8.2% of GDP in Q3 of 2020-21, the second quarter in a row of decline [2].

Don't confuse with

• MPC vs APC: MPC (ΔC/ΔY) is the slope and stays constant on a straight line. APC (C/Y) is the ratio of total consumption to total income. It falls as income rises and is always above MPC when C̄ > 0. APC can exceed 1, but MPC cannot.
• Autonomous vs induced consumption: autonomous consumption (C̄) exists even at zero income and is the intercept. Induced consumption (cY) exists only because there is income and rises with it.
• Saving function: S = −C̄ + (1 − c)Y is the mirror image of the consumption function. Its intercept is negative and its slope is MPS, not MPC.
• Consumption function vs PFCE: the consumption function is a theoretical relation between C and Y. PFCE is the actual measured figure in India's national accounts, covering households and NPISH together.

Prelims Hooks

• C = C̄ + cY: C̄ = autonomous consumption (the intercept), c = MPC (the slope = tan α). The line starts above the origin and is flatter than the 45° line.
• 0 ≤ MPC ≤ 1 (NCERT includes both ends). Trap: APC can be more than 1 and APS can be negative at low income, but MPC and MPS can never be negative or more than 1.
• MPC + MPS = 1 and APC + APS = 1. Both follow from Y = C + S.
• Imagenia (C = 100 + 0.8Y): break-even income = ₹500, and multiplier = 1/(1 − 0.8) = 5.
• PFCE covers households + NPISH together, is estimated by the commodity flow approach, and includes imputed rent of owner-occupied houses [7].
• PFCE ≈ 60.9% of GDP (2022-23), the largest part of aggregate demand. Households gave 60.9% of gross savings in 2022-23, and general government was (−) 7.5% [4][5].

Mains Points

• Targeted transfers give more demand per rupee:
• Poorer households have a higher MPC. With MPC 0.9, a ₹1,000 transfer means ₹900 of spending. A rich household with MPC 0.5 spends only ₹500.
• So in a slowdown, cash transfers to the poor raise demand more than tax cuts for high earners, and a higher c also means a bigger multiplier, 1/(1 − c).

• Because C = C̄ + c(Y − T), a tax cut raises consumption by only c × ΔT. A rupee of direct government spending therefore has a bigger first-round effect than a rupee of tax cut. This is useful for GS-III questions on the quality of fiscal stimulus.

• The saving–consumption trade-off:

• Households give 60.9% of India's gross savings (2022-23) [4][5], and this pool pays for investment.
• Pushing consumption too hard can shrink this pool.

• Saving too much in a slump shrinks demand. This is Keynes's paradox of thrift (when everyone tries to save more, demand and income fall, and total saving may not rise). Policy has to balance the two.

• Crisis behaviour and counter-cyclical policy:

• The forced saving spike of 2020-21 [2][3] shows that fear and lockdowns can shift the consumption function down.
• When private consumption falls like this, government spending and transfers must fill the gap. This supports counter-cyclical fiscal policy, meaning the government spends more in bad times and less in good times.

Related concepts

• Autonomous consumption
• Induced consumption
• Marginal propensity to consume
• Marginal propensity to save
• Average propensity to consume
• Average propensity to save
• Savings

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• Consumption, saving and the propensities