701 Consumption

red_mouth_eating_dark_chocolateConsumption contributes tremendously to our nation’s GDP growth. In America, it is estimated that at least 60% of the GDP is tabulated from household consumption alone. Remember what we discussed in the Prelude to Macroeconomics? What we spend becomes somebody’s income! Therefore, the more we spend, the more we earn! That is why governments all over the world are working day and night to stimulate spending in their economies!

Have you ever wondered how your spending habits would change if you were extremely poor? I’m sure you would have very different spending habits as compared to your life now. But what are the things you buy that would be similar as compared to your rich lifestyle? I can think of a few:

  • Basic Education (At least here in Singapore, it’s compulsory)
  • 1 meal a day
  • Clothing
  • Shelter
  • and many more that satisfy our basic needs (For an interesting outlook, check out the Maslow Hierarchy of Needs)

When we add them all together, we call it AUTONOMOUS CONSUMPTION, which is consumption that is not dependable on income.

So let’s say we now have more disposable income. By the way, what’s disposable income? It’s the income that we are entitled to spend after paying off all our taxes. With disposable income, we now have the freedom to spend or save a certain proportion of it!

And how do different taxes affect our consumption and the economy? We will be exploring more into that after we finish covering all the components of how GDP is calculated.

At the end of this video, you should be able to:

  1. Identify approaches to how GDP is calculated
  2. Explain why at equilibrium, Aggregate expenditure = Income
  3. Understand the 2 major components of consumption: Income dependent and independent consumption
  4. Tell the difference between lump sum and proportional taxes
  5. Construct the consumption function which includes taxes, disposable income and marginal propensities to consume
  6. Define spending habits between the rich and poor
  7. handle government imposed transfers

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15 Comments

  1. Dayvid says:

    So how do the part on poor/rich divide comes into the picture, and how do we apply this concept? eg what kind of questions?

    • Quickienomics says:

      Hi Dayvid,
      You will see it in questions that specifically state that there is a portion of rich people and a portion of poor people. and if that is the case. u have to use the concept where the poor/rich earn a certain portion of the income. If u don’t, there will be double accounting of income earned.

  2. Your web site is helpful to me. Thank you!

  3. Eleana says:

    When you talk about transfers,is it random that you applied them only to the proportional taxes equations? Or same logic can apply to lump sum taxes equations?

  4. Romona says:

    The proportional transfers formula confuse me. Shouldn’t the amount in the square brackets add back to Y? or Y(1-t) in this case where you are using a proportional tax, (ie everyone being taxed t% (ie the 1-t part of the equation)? I tried putting figures in the equation and they just don’t make sense!

    I am thinking that you need to subtract off a proportional amount from the rich and add that on to the poor….

    What am I missing here?

    Thanks,
    Romona
    ps, is there anyway you can set this up to send notifications when comments have been added? 😀

    • Quickienomics says:

      Hi Romona,

      I’m sorry but I don’t get your confusion here but the percentages in the taxes for rich and poor are different so they shouldn’t amount up to the same Y. Are you referring to like a balanced budget policy?

  5. Nigel says:

    Hi dude,

    Thanks for the great site.

    Just need to clarify this.

    For “Proportionate Transfers” whereby a percentage of the rich people’s income are transferred over, shouldn’t the “Poor People’s” be C[(1-t)(1-a)(1+b)Y] instead of C[(1-t)(1-a)(b)Y]?

    • Quickienomics says:

      Hi Nigel,

      I’m glad it managed to help you.

      It cannot be 1+b because if that’s the case, that means the rich gets 100% of the income. You can’t come up with a more than 100% income and that’s what you’re implying with 1+b

  6. Romona says:

    Ok.. I am not sure if I can explain this properly… in the transfers formula where you subtracted 1-b from the rich and added b to the poor… I don’t understand it, because that would mean that the total income (Y) would not tally back – you are taking b% of Y for the poor, but shouldn’t it be their (the poor) original income + bY? (you have the formula as C1R[(1-t)a(1-b)Y] + C1P[(1-t)(1-a)bY] but I am thinking it should be C1R[(1-t)aY – b(1-t)aY] + C1P[(1-t)(1-a)Y + b(1-t)aY] – this way you are taking away b% of income from the rich and giving that same b to the poor. And the amount in the square brackets before the % transfer is equal to the amount in the square brackets after the transfer, in other words, the total amount of disposable in the economy has not changed, it has just been redistributed.) Or am I totally off base here?

    Thanks as always!
    Romona

    • Quickienomics says:

      Hi Romona,

      Wow, that’s quite a bit of math you’ve been doing. lol! Okay, now I understand what you are saying. But you’re saying now that the total amount of disposable income is the same. It’s only been redistributed. Maybe you could tell me what the issue is with that? Because a transfer is basically the rich allocating some fund to the poor, so technically, total disposable income shouldn’t change.

      • Romona says:

        exactly Gerald! TOTAL disposable income should not change, it has just been reallocated. However, in the formula you gave in the video, when I put figures into it, the totals are not the same… which is why I was confused and was wondering if I was missing something…

        Thanks!
        Romona

        • Siddharth says:

          He got too bored of you and stopped replying 😛

          I think Romona, the formula given in the video is correct. You should probably recheck it.

  7. Rishi Purohit says:

    So i was guided to your blog by a friend and must say its amazing stuff..
    coming to the point..
    in your equation for the Economy after you introduced the rich and the poor as “alpha: ratio of rich” and “1- Alpha: as population proportion of the poor”, you state that income of the rich is “alpha.Y” but considering the cliche of 1% population holding 90% of the worlds resources, where does this hold then? we will end up multiplying “alpha” which is 0.01, with Y which may be anything for the rich and then 0.9 into Y again and this is not representative of reality.. Please help..

    Thanks a lot..
    Rishi (india)

  8. Prateeth says:

    Hey Rishi,

    I’m guessing he meant Alpha as the percentage of the TOTAL INCOME earned.

    Prateeth.