Consumption Function

GDP components -  

• consumption (C) - goods/services purchased by consumers
• investment (I) - aka fixed investment, purchase of capital goods
  • more long term, more of an investment (intention = save)
  • general, ambiguous definition varying for every country
• gov't spending (G) - purchases of goods/services by federal/state/local gov't
  • doesn't include gov't transfers, interest on debt
  • ie. doesn't include social security benefits, Medicare, etc
• net exports - difference between exports and imports
  • aka trade balance
  • imports - purchase of foreign goods by consumers, business, gov't
  • exports - purchase of US goods/services by foreigners
• closed economy >> no exports/imports >> demand = consumption+investment+gov't spending

consumption function - C(Y_D)  

• disposable income (Y_D) - income remaining after paying taxes, receiving gov't transfers
  • Y_D = Y-T
• C = c₀+c₁(Y_D)
• c₀ - intercept of consumption function, consumer confidence
  • minimal consumption, what consumer would buy w/ no income (necessities)
• c₁ - propensity to consume >> effect of an additional dollar on consumption
  • (0<c₁<1)
  • ie. c₁=0.5 >> consumer will spend an extra $0.5 for every extra dollar of disposable income
• endogenous variables - depends on other variables within the model
  • consumption depends on income >> endogenous
• exogenous variables - constant, not explained within the model, taken as a given
  • investment - taken as a given in closed economies

• with disposable income at 0 (ie. you're not making any money), consumption is still at c₀
• consumers would have to borrow to consume at c₀