The Consumption Function

Class 12 Macro Economics — The relationship between income and spending, and why we do not spend everything we earn.

Meaning of Consumption Function

Before we understand the consumption function, we need to be clear about what “consumption” means in economics.

Consumption Expenditure (C)

The total money value of all goods and services purchased by households in a given period. It includes everything from groceries and rent to electricity bills and movie tickets — but excludes spending on buying a house (which is investment).

Consumption Function

The functional relationship between total consumption expenditure (C) and national income (Y). It shows how much households plan to spend at each level of income. Represented as C = f(Y).

Consumption Function (General Form)

$$C = f(Y)$$

Consumption ≠ Consumption Function

Consumptionis the actual amount spent — a specific number like “\u20B9400 crore.”

Consumption Function is the relationship between income and spending — the rule or equation that tells us how much will be spent at different income levels.

Think of it like a vending machine: “\u20B920” (consumption) is the actual snack you get. The price list showing “each snack costs \u20B920” (the rule) is the consumption function.

Consumption Schedule and Observations

A consumption schedule is a table showing planned consumption at different income levels. Let us look at a simple example.

Consumption Schedule — How spending changes with income
Income (Y) ₹ crores	Consumption (C) ₹ crores
0	40
100	120
200	200
300	280
400	360
500	440
600	520

Consumption Curve Explorer

\u2190 Drag to see consumption at each income level \u2192

Income (Y)

\u20B9200 cr

Consumption (C)

\u20B9200 cr

Dissaving

₹0 cr

5 Key Observations from the Consumption Schedule

Consumption starts above zero: Even at Y = 0, consumption is \u20B940 crore — this is autonomous consumption (\u0100). People must eat and survive regardless of income.
Consumption rises with income: As Y increases, C also increases. More income means more spending.
Consumption rises slower than income: Each additional \u20B9100 of income leads to only \u20B980 more spending (MPC = 0.8). The remaining \u20B920 is saved.
Break-even point: At Y = \u20B9200 crore, C = Y = \u20B9200 crore. Everything earned is spent — saving is zero.
Below break-even = dissaving: When Y < \u20B9200 crore, C > Y. People spend more than they earn by using past savings or borrowing.

What is the 45° Line?

The 45° line is a reference line where Y = C (or more generally, Y = Expenditure). Every point on this line has the same value on both axes — income equals spending.

Why use it? It helps us see at a glance whether consumption is above or below income at any point.

Exam tip: The 45° line is NOT the consumption curve. It is just a visual reference. The consumption curve is the actual relationship between Y and C. The vertical gap between the consumption curve and the 45° line shows saving (if C is below) or dissaving (if C is above).

Keynesian Psychological Law of Consumption

John Maynard Keynes observed three fundamental truths about how people spend their income. He called this the “Psychological Law of Consumption” because it is rooted in human psychology, not mathematical derivation.

Minimum consumption even at zero income

Now

Even if income falls to zero, people must eat, wear clothes, and keep a roof over their heads. This minimum spending is called autonomous consumption (Ā). It is financed by past savings, selling assets, or borrowing.

As income rises, consumption also rises

Step 2

When people earn more, they naturally spend more. If you get a raise at work, you will likely eat out more, buy better clothes, or upgrade your phone. Consumption and income move in the same direction.

But income rises faster than consumption

Step 3

This is the key insight. When your income increases by ₹100, you do not spend all ₹100. You spend some (say ₹80) and save the rest (₹20). The proportion spent is MPC, and it is always less than 1.

Step 1 of 3

Average Propensity to Consume (APC)

APC tells us, on average, how much of our total income we spend on consumption. It is the ratio of total consumption to total income.

Average Propensity to Consume

APC =

C (Total Consumption)Y (Total Income)

Average Propensity to Consume (APC)

The ratio of total consumption expenditure to total income. It shows the proportion of income that is spent on consumption. APC = C / Y.

Example

If your monthly income is \u20B930,000 and you spend \u20B924,000, then:

APC = 24,000 / 30,000 = 0.80 (or 80%)

You spend 80 paise out of every rupee you earn.

APC Schedule — How APC changes with income
Income (Y) ₹ cr	Consumption (C) ₹ cr	APC = C/Y
0	40	—
100	120	1.20
200	200	1.00
300	280	0.93
400	360	0.90
500	440	0.88
600	520	0.87

Key Takeaways

APC > 1 before break-even (Y < ₹200 cr): People spend more than they earn by borrowing or using savings.
APC = 1 at break-even (Y = ₹200 cr): C = Y — everything earned is consumed, nothing is saved.
APC < 1 after break-even (Y > ₹200 cr): People spend less than they earn — the rest is saved.
APC falls as income rises: When you earn ₹100, you might spend ₹120 (APC = 1.20). When you earn ₹500, you spend ₹440 (APC = 0.88). You are saving more.
APC can never be 0: Even at very high incomes, people still consume something. You cannot survive without any consumption.

Marginal Propensity to Consume (MPC)

While APC looks at total consumption, MPC looks at what happens when income changes by a small amount. It measures the rate of change of consumption.

Marginal Propensity to Consume

MPC =

ΔC (Change in Consumption)ΔY (Change in Income)

Marginal Propensity to Consume (MPC)

The ratio of change in consumption to change in income. It measures how much of each additional rupee of income is spent on consumption. MPC = \u0394C / \u0394Y.

Example

Suppose you get a bonus of \u20B910,000. You decide to spend \u20B97,500 of it and save \u20B92,500.

MPC = 7,500 / 10,000 = 0.75 (or 75%)

You spend 75 paise of every extra rupee. The remaining 25 paise is saved (MPS = 0.25).

MPC Schedule — Change in consumption per unit change in income
Income Range (₹ cr)	ΔC (₹ cr)	ΔY (₹ cr)	MPC = ΔC/ΔY
0–100	80	100	0.80
100–200	80	100	0.80
200–300	80	100	0.80
300–400	80	100	0.80
400–500	80	100	0.80
500–600	80	100	0.80

Key Takeaways

MPC is always between 0 and 1: (0 < MPC < 1). People never spend 100% of extra income (MPC = 1) nor 0% (MPC = 0). In reality, MPC is between 0.5 and 0.9 for most people.
MPC of a poor person is higher than MPC of a rich person: If a poor person gets ₹100 extra, they will spend most of it on necessities (MPC close to 1). A rich person will save most of it (MPC close to 0).
MPC falls as income rises: At low incomes, extra money goes to urgent needs (food, rent). At high incomes, needs are already met, so more is saved.
MPC + MPS = 1 always: Every extra rupee is either consumed or saved. If MPC = 0.75, then MPS = 0.25.
The slope of the consumption curve equals MPC: A steeper curve means higher MPC (people consume more of each extra rupee). In our example, MPC = 0.8, which is the slope of the C curve.

Slope of Consumption Curve = MPC

Look at the consumption curve graph above. The consumption curve is a straight line in our example. Its slope is \u0394C / \u0394Y = 80/100 = 0.8.

This is not a coincidence. The slope of any consumption function is always the MPC. When you see the consumption curve, its steepness tells you how much people spend out of extra income.

MPC Sensitivity — See How MPC Changes

Adjust the four sliders to create your own scenario. Watch how MPC changes in real time.

Initial Income (Y\u2081)\u20B9100

New Income (Y\u2082)\u20B9200

Initial Consumption (C\u2081)\u20B9120

New Consumption (C\u2082)\u20B9200

When income rises from \u20B9100 to \u20B9200 (\u0394Y = 100) and consumption rises from \u20B9120 to \u20B9200 (\u0394C = 80):

MPC = 0.80

Most of the extra income is being consumed.

\u0394Y (Income change)

100

\u0394C (Consumption change)

MPS

0.20

APC vs MPC — Key Differences

Students often confuse APC and MPC. Let us clearly see how they are different.

APC vs MPC
Aspect	APC (Average Propensity to Consume)	MPC (Marginal Propensity to Consume)
Meaning	Ratio of total consumption to total income at a given level of income.	Ratio of change in consumption to change in income.
Can be > 1?	Yes — when C > Y (before break-even), APC > 1.	No — MPC is always between 0 and 1. You never spend more than the extra income.
Response to income change	APC falls continuously as income rises (but remains positive).	MPC may remain constant (in a linear function) or fall. It is generally higher for poorer people.
Formula	APC = C / Y (stock/total)	MPC = ΔC / ΔY (flow/change)

Slope of Consumption Curve is MPC, not APC

This is a very common mistake in exams. When you see a consumption curve graph:

Slope of the C curve = \u0394C / \u0394Y = MPC
Position of a point on the C curve = C / Y = APC

Think of it this way: MPC tells you how steep the curve is. APC tells you how high the curve is at a given point.

Key Takeaways

Consumption function (C = f(Y)) shows the relationship between income and spending. It is always a positive relationship.
Autonomous consumption (Ā) is the minimum spending even at zero income — financed by borrowing or past savings.
Keynes' Psychological Law: (1) Minimum consumption at zero income, (2) Consumption rises with income, (3) Income rises faster than consumption.
APC = C/Y. It falls as income rises. APC > 1 before break-even, APC = 1 at break-even, APC < 1 after break-even. APC can never be 0.
MPC = ΔC/ΔY. It lies between 0 and 1. MPC of poor people is higher than MPC of rich people. MPC + MPS = 1 always.
The slope of the consumption curve = MPC (not APC). A steeper curve means people spend more of each additional rupee.

The Consumption Function

Notes

The Consumption Function

Meaning of Consumption Function

Consumption Schedule and Observations

Keynesian Psychological Law of Consumption

Average Propensity to Consume (APC)

Marginal Propensity to Consume (MPC)

APC vs MPC — Key Differences

Key Takeaways