APMacro: Consumption and Saving


20 Income Consumption Saving Graph
Consumption and saving affect disposable income. Households can only do two things with their income: spend it or save it. The consumption function demonstrates that those with lower disposable incomes spend a higher percentage of their incomes and save less or even dissave, while those with higher disposable incomes spend a smaller percentage of their incomes and have a higher percentage of saving.
APC
The average propensity to consume (APC) is the percentage of total income spent,
APS
while the average propensity to save (APS) is the percentage of total income saved. By definition, APC + APS = 1, because the percentages of income spent and saved must add up to total disposableĀ income.
MPC
The marginal propensity to consume (MPC) is the percentage of the change in income spent,

MPS
while the marginal propensity to save (MPS) is the percentage of the change in income saved. As with the average propensities, MPC + MPS = 1, or 100% of the change in income.

While disposable income is the most important determinant, other factors also affect the level of household spending and saving. The wealth effect illustrates that when household wealth increases, consumption increases and saving decreases. Borrowing allows households to temporarily increase consumption, but it reduces future consumption when the loan must be repaid. Households increase consumption ahead of expected inflation, while they decrease consumption and save money when they fear a pending recession may result in unemployment. Changes in real interest rates also slightly affect spending and saving. Lower interest rates increase spending, as lower loan payments entice consumers to buy homes and cars on credit. At the same time, the low interest rates discourage households from saving.

Arrows-02-june

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