Consumption, saving and the propensities

Detail

1. Where this idea comes from

• J.M. Keynes wrote The General Theory of Employment, Interest and Money in 1936, during the Great Depression.
• At that time, demand had collapsed, factories were idle and workers had no jobs.
• Keynes said that total output depends on aggregate demand (the total spending planned in the economy).

• Consumption is the largest part of this demand. So we must first understand how people decide to spend or save.

• In India, private final consumption expenditure (PFCE) is the national-accounts measure of household consumption. It was 61.0% of GDP in 2021-22 and 60.9% in 2022-23 at current prices [4][5].

• So about ₹6 of every ₹10 of GDP is private consumption. This is why the consumption function matters so much.

2. The consumption function

• Consumption function: the relation between consumption (C) and income (Y).

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

• Equation 4.1: C = C̄ + cY

• C̄ (C-bar) is autonomous consumption.
• cY is induced consumption.
• c is the marginal propensity to consume (MPC).

Autonomous consumption (C̄)

• Definition: the part of consumption that does not depend on income.
• It takes place even when income is zero. A family must eat and keep a roof over its head even with no income.
• It is the subsistence level of spending (the bare minimum needed to survive).
• How is it paid for when income is zero?
• by dissaving (using up past savings), or
• by borrowing.

Induced consumption (cY)

• Definition: the part of consumption that depends on income. It rises when income rises.
• Example: if c = 0.8 and Y = ₹1,000, then induced consumption = 0.8 × 1,000 = ₹800.

3. Marginal propensity to consume (MPC)

• Definition: the change in consumption for each unit change in income.

• MPC = ΔC/ΔY = c (Δ means "change in").

• Range: 0 ≤ MPC ≤ 1. NCERT includes both end points:

Value of MPC	Meaning
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 consumed

• MPC can never be more than 1. ΔC cannot be larger than ΔY.
• (Extra spending beyond the extra income would have to come from past savings or loans. That is not part of the marginal response to income.)

Worked example: Imagenia

• C = 100 + 0.8Y
• At Y = 0, C = ₹100. So autonomous consumption = ₹100.

• MPC = 0.8. If income rises by ₹100, consumption rises by 0.8 × 100 = ₹80. The other ₹20 is saved.

• Check with two income levels:

• Y = 1,000 → C = 100 + 800 = 900
• Y = 1,100 → C = 100 + 880 = 980
• ΔC/ΔY = 80/100 = 0.8 ✔

4. Graph of the consumption function

• Intercept form of a straight line: Y = a + bX
• a = intercept (where the line cuts the vertical axis).

• b = slope = tan θ (θ is the angle the line makes with the horizontal axis).

• Applied to C = C̄ + cY, with income on the horizontal axis and consumption on the vertical axis:

• Intercept = C̄. The line starts above the origin, because people consume even at zero income.

• Slope = c = tan α. Since 0 < c < 1, the line is flatter than a 45° line.

• The 45° line (where C = Y) helps us read the graph:

• Where the consumption line crosses the 45° line, C = Y and saving = 0. This is the break-even point.
• In Imagenia: 100 + 0.8Y = Y → 0.2Y = 100 → Y = ₹500.
• Below ₹500, the consumption line is above the 45° line. C > Y, so households dissave.
• Above ₹500, C < Y, so households save.

5. Saving and its propensities

• Saving (S): the part of income that is not consumed.

• S = Y − C

• Saving function (found by putting C = C̄ + cY into S = Y − C):

• S = −C̄ + (1 − c)Y
• Imagenia: S = −100 + 0.2Y
• The intercept is −C̄. At zero income, saving = −₹100, which is pure dissaving.
• The slope is s = 1 − c = 0.2.

Marginal propensity to save (MPS)

• Definition: the change in saving for each unit change in income.

• MPS = ΔS/ΔY = s

• Derivation:

• s = Δ(Y − C)/ΔY = ΔY/ΔY − ΔC/ΔY = 1 − c

• So s = 1 − c, and MPC + MPS = 1.

• Why they add to 1: each extra rupee of income is either spent or saved. There is no third use in this simple model.

• Imagenia: MPC 0.8 + MPS 0.2 = 1 ✔

• Range of MPS: 0 ≤ MPS ≤ 1, the mirror image of MPC.

Average propensity to consume (APC)

• Definition: consumption per unit of income.

• APC = C/Y

• Example: Y = 1,000, C = 900 → APC = 0.90. Households spend 90 paise of every rupee of income.

Average propensity to save (APS)

• Definition: saving per unit of income.

• APS = S/Y

• Example: Y = 1,000, S = 100 → APS = 0.10.

APC + APS = 1

• Since C + S = Y, dividing both sides by Y gives C/Y + S/Y = 1.
• So APC + APS = 1 at every income level.

6. Average vs marginal (a standard extension)

• Divide the consumption function by Y:
• APC = C/Y = C̄/Y + c

• Because C̄/Y > 0 (when C̄ > 0), APC > MPC at every income level.

• APC falls as income rises:

• As Y grows, C̄/Y gets smaller, so APC falls.

• APC moves closer and closer to MPC, but it never goes below MPC.

• MPC stays constant (0.8) along a straight-line consumption function.

Imagenia (C = 100 + 0.8Y):

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

• The Y = 0 and Y = 250 rows are added to show dissaving. The other rows are from the scaffold.
• At low income, APC can be more than 1.
• This means households are dissaving (spending more than they earn).

• APS is then negative (e.g. −0.20 at Y = 250).

• But MPC can never be more than 1, even when APC is.

• This is a common exam trap: APC > 1 is possible, MPC > 1 is not.

• APS rises as income rises (0 → 0.10 → 0.15). Richer households save a larger share of their income.

7. Link to the multiplier (preview)

• The size of MPC decides how strongly income responds to new spending.
• Investment multiplier = 1/(1 − c) = 1/s

• Imagenia: 1/(1 − 0.8) = 1/0.2 = 5. ₹100 of new investment finally raises income by ₹500.

• Higher MPC → bigger multiplier. More of each round of income gets spent again.

8. Policy angle

• Poorer households have a higher MPC.
• Worked example: a poor household with MPC 0.9 gets ₹1,000. It spends ₹900.
• A rich household with MPC 0.5 gets the same ₹1,000. It spends only ₹500.

• So a transfer to the poor adds more to demand than the same transfer to the rich.

• With a government, consumption depends on disposable income:

• Disposable income (Yd): the income households actually have in hand after paying taxes and receiving transfers.
• Yd = Y − T (+ transfers)
• So C = C̄ + c(Y − T)
• Worked example (Imagenia, Y = 1,000):
  • T = 0 → C = 100 + 0.8 × 1,000 = 900
  • T = 100 → C = 100 + 0.8 × 900 = 820
  • A ₹100 tax cuts consumption by ₹80 (= c × ΔT), not by the full ₹100. Households also save ₹20 less.

• This links to personal disposable income in national income accounting.

• How India measures consumption:

• 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 also includes the imputed rent of owner-occupied dwellings (the rent people "pay themselves" for living in their own house) and home-grown produce that people consume themselves [7].
• Households and NPISH are estimated together. They are not shown separately [7].
• PFCE is estimated by the commodity flow approach: start from the total supply of each good, then subtract its other uses (industry inputs, government use, capital formation, stocks, net exports) [7].

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

• Latest consumption trend: PFCE was estimated to grow 7.6% in 2024-25, up from 5.6% in 2023-24 [6].

• Who saves in India: shares in gross savings in 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, meaning it spent more on current needs than its current income.

• Longer view of household saving (as % of GDP at current market prices, 2006-07) [9]:

• Household financial saving: 11.8%
• Saving in physical assets (houses, gold and similar): 12.5%
• Total household saving: 23.8%

• PFCE was 55.8% of GDP in 2005-06 [9]. By 2022-23 it was about 61% [4][5].

• Saving in a crisis (COVID-19):

• Household financial savings spiked in Q1 of 2020-21. This was against the usual seasonal pattern.
• The likely reason was forced saving: during the lockdown, people could not spend on non-essentials [3].
• The rate then eased to 8.2% of GDP in Q3 of 2020-21, the second quarter in a row of decline [2].
• Lesson: C̄ and c are not fixed for ever. Fear and lockdowns can shift the whole consumption function down.

Prelims Hooks

• C = C̄ + cY: C̄ = autonomous consumption (the intercept), c = MPC (the slope = tan α).
• MPC = ΔC/ΔY, and 0 ≤ MPC ≤ 1. NCERT includes both 0 and 1. MPC can never exceed 1.
• Trap: APC can exceed 1 at low income (dissaving), but MPC cannot. APS can be negative, but MPS cannot.
• MPC + MPS = 1 and APC + APS = 1. Both follow from Y = C + S.
• With a positive C̄, APC > MPC, and APC falls as income rises. MPC stays constant on a straight-line consumption function.
• Imagenia (C = 100 + 0.8Y): ₹100 more income → ₹80 more consumption. Break-even income = ₹500. Multiplier = 1/(1 − 0.8) = 5.
• Saving function: S = −C̄ + (1 − c)Y. Its intercept is negative.
• PFCE covers households + NPISH together. It is estimated by the commodity flow approach and includes imputed rent of owner-occupied houses [7].
• Household sector = 60.9% of India's gross savings in 2022-23. General government was negative (−7.5%) [4][5].
• PFCE ≈ 60.9% of GDP (2022-23) [4][5]. It is the largest component of aggregate demand.

Mains Points

• Targeted transfers give more demand per rupee:
• Poorer households have a higher MPC.
• So in a slowdown, cash transfers to the poor lift demand more than tax cuts for high earners.

• Link this to the multiplier: 1/(1 − c) is higher when c is higher.

• The saving–consumption trade-off:

• Households give 60.9% of India's gross savings (2022-23) [4][5]. This money finances investment.
• Pushing consumption too hard can shrink this pool.
• Too much saving in a slump, on the other hand, shrinks demand. This is Keynes's paradox of thrift.

• Policy has to find a balance between the two.

• Crisis behaviour:

• The COVID-19 forced saving spike in 2020-21 [2][3] shows that the consumption function can shift down when people are afraid.

• This supports counter-cyclical fiscal policy (spending more in bad times). Government spending and transfers can step in when private C falls.

• Tax policy works through disposable income:

• Because C = C̄ + c(Y − T), a tax cut raises consumption by only c × ΔT, not the full ΔT.
• So a rupee of direct government spending has a bigger first-round effect on demand than a rupee of tax cut.
• This matters for GS-III questions on the quality of fiscal stimulus.