SummaryIn this Learning Path, we learn the basic concepts needed to start studying any country’s economy. Even though the analysis should start by assuming either a closed or open economy, this LP omits such concepts, and gives just the very basic notions required to study macroeconomics.
Measuring the production of an economy:
- Government spending
- Net exports
Consumption is one of the components of a country’s gross domestic product. It can be defined as the spending on goods and services made by households. Consumption includes only the expenses for final use, not with the intention of generate another product.
Household or private consumption is mainly determined by disposable income (YD), which is the money they have earned from wages and other retributions from the firms’ use of factors of production, after government intervention (subtracting taxes from unemployment benefits and other transfers). At the same time, the disposable income is influenced by the marginal propensity to consume (c1) of households, which is between 0 and 1. However, there is a minimum level of consumption (c0), also called autonomous consumption, which households make, independently of their disposable income. Therefore, we have:
C = c0 + c1 YD
Looking at this formula, we can see that households’ consumption may be higher than their disposable income. For example, when the disposable income is zero, the consumption is equal to c0, a figure different from zero. This is possible because households can borrow money or reduce their savings. Savings are the part of the disposable income that households do not spend, the money they keep, for example, in a bank account. Past savings may allow households to consume during a period more than their disposable income.
This function was first introduced by John Maynard Keynes in his “The General Theory of Employment, Interest and Money”, 1936. Thanks to his work, he is considered as the father of macroeconomics.