Income and Consumption Relationship

• As income increases, people will consume a fraction of each additional dollar earned.
  • This fraction is referred to as the marginal propensity to consume (MPC).

Consumption Schedule

• The consumption schedule is a graphical representation that illustrates the relationship between income and consumption.
• In the consumption schedule:
  • Consumption is plotted on the vertical axis.
  • Disposable income is plotted on the horizontal axis.

Autonomous Consumption

• At point A on the graph:
  • Disposable income equals zero.
  • Consumption is not zero due to the necessity of expenditures for basic needs (food, shelter).
  • This level of consumption is termed autonomous consumption because it is independent of current income.

Relationship Between Disposable Income and Consumption

• As disposable income increases, consumption also increases, though not by the full dollar amount due to the MPC being less than one.
  • Example:
  • With a part-time job, an individual spends on more than necessities.
  • With a full-time job, an individual could afford larger purchases (e.g., a car).
• By connecting the plotted points, the consumption schedule (C) can be traced.
  • The slope of the consumption schedule is defined as:
  • $ext{slope of C} = \frac{\Delta C}{\Delta DI}$
  • Here, $\Delta DI$ denotes the change in disposable income.
• In the absence of taxes, income (Y) equals disposable income (DI). Thus, the formula transforms to:
  • $ext{slope of C} = \frac{\Delta C}{\Delta Y}$
  • This shows that the slope of the consumption schedule equals the marginal propensity to consume (MPC).

Aggregate Expenditures Equation

• The overall equation for aggregate expenditures is expressed as:
  • $Y = C + I + G + NX$
  • Where:
  • Y = real GDP or income
  • C = consumption
  • I = gross investment
  • G = government purchases
  • NX = net exports
• Initially focusing on consumption, in the absence of gross investment, government purchases, and net exports, the equilibrium condition simplifies to:
  • $Y = C$
• Since it is assumed there are no taxes, the economy achieves equilibrium when:
  • $DI = C$
• A line can be drawn, labeled C = DI, tracing all points where disposable income equals consumption.
  • This line is known as the equilibrium line and rises at a 45-degree angle from the origin.
• The equilibrium state manifests where the consumption schedule (C) intersects with the C = DI line.
  • At this intersection point, consumption $C<em>1$ equals disposable income $DI</em>1$.

Incorporating Taxes into the Model

• To make the model more realistic, taxes are reintroduced:
  • Disposable income is adjusted to:
  • $DI = Y - T$
  • Where T represents taxes.
• In the aggregate expenditures model, taxes are treated as a lump sum that is independent of personal income levels.
• With changes in real GDP $\Delta Y$, changes in disposable income $\Delta DI$ adjusts similarly, given that changes in taxes $\Delta T = 0$.
• Despite these adjustments, the shape of the consumption schedule remains unchanged; only the vertical intercept varies.
• The graph is relabeled to show real GDP (Y) on the horizontal axis, leading to a new equilibrium at consumption $C<em>2$ and real GDP $Y</em>2$.

Importance of the Consumption Schedule

• As the aggregate expenditures model evolves, the consumption schedule becomes vital in understanding the interactions within the economy.
• It forms the foundation for relating income and consumption, which is critical for analyzing economic behaviors and trends.