Syndicate
C stands For Consumption
The expense of the households represents almost seventy percent of the GDP – which is much more than the other three combined. Many factors affect what part of the revenues the households decide to consume and what part they decide to save for the future.
Microeconomists dedicate a lot of time at studying the diverse factors that affect those decisions, amongst these the expectations on how bright or dark the future looks and how high or low the interest rates are over the revenues. Macroeconomists on the other hand do not come very near these factors because when economics is studied as a whole, the thing that really matters is total consumption, and not just the reason why households decide to choose a specific amount.
Macroeconomists have a very simple way of building the consumption models, as a function of the available revenues, or after taxes. It is possible to obtain the available income algebraically by using the following very practical process that has three stages to it:
- You will want to start out with the Y, which is the total income in the economy. In Keynes equation, Y is the same as total expenses, but since expenses are the same as income, it also helps to calculate the income. Remember that any money that you spend is an income for someone else.
- Calculate the taxes that people will have to pay. In order to make this a bit easier, suppose that the only tax is an income tax and that the rate of this tax is represented by t. For example, t = 0,25 would mean a tax rate of 25 percent of the income of the people. As a consequence, the total taxes that the people have to pay, T, would be given for T = t*Y.
- Deduct the taxes, T, of the income, Y, to calculate the income after taxes. Economists refer to this value as available income.
After deriving the available income, use a simply model to calculate the household consumption expenses. The models says that consumption, C, is function of the available income and a couple other variables, C o and c.
C = C o + c*Y D
Here C represents about the marginal propensity to consume, or PMC, which is always a number between zero and one that indicates the rate that consumes its income instead of saving it up. To make it a little bit more clear, if c = 0,08 then you are consuming 80 cents of each incoming dollar that you have after paying taxes, and the rest is what is saved up, which in this case is 20 cents.
The present value of the marginal propensity to consume, c, is determined by the individual and varies from person to person depending on what part of available income he or she likes to save up on. All right so what the hell is C o? It is what the people consume even if they do not have any available income this year. However, where does the money come from in order to pay for C o if there is not any income available? It comes from personal savings that you have saved up during a few years.
What the equation C = C o + c*Y D actually says is that the total amount of your consumption expense in a economy will be your level of emergency (such as when you do not have any income) C o plus one part of your available income given by c*Y D.