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THREE-SECTOR, THREE-MARKET CIRCULAR FLOW: A circular flow model of the macroeconomy containing three sectors (business, household, and government) and three markets (product, factor, and financial) that illustrates the continuous movement of the payments for goods and services between producers and consumers, with particular emphasis on taxes and government purchases. Other circular models are two-sector, two-market circular flow; two-sector, three-market circular flow; and four-sector, three-market circular flow.

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INDUCED CONSUMPTION:

Household consumption expenditures that depend on income or production (especially disposable income, national income, or even gross domestic product). That is, changes in income induce changes in consumption. Induced consumption captures the fundamental psychological law put forth by John Maynard Keynes. It is measured by the marginal propensity to consume (MPC) and is reflected by the positive slope of consumption line. The alternative to induced consumption is autonomous consumption, which does not depend on income.
Induced consumption is consumption expenditures by the household sector that are based on the level of income or production. This is one of two basic classifications of consumption. The other is autonomous consumption, consumption expenditures that are NOT based on the level income or production. In other words, household consumption can be divided into: (1) a minimum or baseline amount of expenditures which, in theory, would be undertaken even if the household sector had no income and (2) additional expenditures that result from the income available to the household sector.

Consumption expenditures are induced because people are prone to spend the income they have. If they have more income, then they are inclined (that is, induced) to spend more. If they have less income, then they spend less. Induced consumption simply means that income is the most important factor affecting consumption expenditures. Other factors are important, but income is at the top of the list. People cannot buy if they have no income.

Induced consumption plays a critical role throughout the study of Keynesian economics. First and foremost, induced consumption is key to effective demand and embodies the fundamental psychological law that John Maynard Keynes proposed as an essential difference between his theory and classical economics.

Induced consumption is then reflected by the slope of the consumption line and the marginal propensity to consume (MPC). The MPC is important to the slope of the aggregate expenditures line which also affects the value of the expenditures multiplier.

Induced Through An Equation

One way to illustrate induced consumption is with the consumption function, such as the equation presented here:
C=a+bY
where: C is consumption expenditures, Y is income (national or disposable), a is the intercept, and b is the slope.

The two key parameters that characterize the consumption function are slope and intercept. Induced consumption is indicated by the slope of the consumption function. Autonomous consumption is indicated by the intercept.

  • An Induced Slope: The slope of the consumption function (b) measures the change in consumption resulting from a change in income. If income changes by $1, then consumption changes by $b. This slope is generally assumed and empirically documented to be greater than zero, but less than one (0 < b < 1). It is conceptually identified as induced consumption and the marginal propensity to consume (MPC).

  • An Autonomous Intercept: The intercept of the consumption function (a) measures the amount of consumption undertaken if income is zero. If income is zero, then consumption is $a. The intercept is generally assumed and empirically documented to be positive (0 < a). It is conceptually identified as autonomous consumption.

Induced Through A Line

Consumption Line
Consumption Line

Another common way to identify induced consumption is with a standard consumption line, such as the one presented in the exhibit to the right. This is reasonable because the consumption line is a graph of the consumption function. The red line, labeled C in the exhibit, is the positively-sloped consumption line for the equation: C = 1 + 0.75Y. This line indicates that greater levels of income generate greater consumption expenditures by the household sector.

For reference, a black 45-degree line is also presented in this exhibit. Because the 45-degree line has a slope of one, it indicates that the induced slope of the consumption line is less than one.

The two primary characteristics of the consumption function--slope and intercept--are also identified by the consumption line.

  • An Induced Slope: The slope of the consumption line presented here is positive, but less than one. In this case the slope is equal to 0.75. Click the [Slope] button to highlight. Once again this is induced consumption and the marginal propensity to consume (MPC).

  • An Autonomous Intercept: The consumption line intersects the vertical axis at a positive value of $1 trillion. Click the [Intercept] button to highlight. And once again this is autonomous consumption.

Other Induced Expenditures

Consumption is perhaps the most important, but certainly not the only induced expenditure. The other three aggregate expenditures--investment expenditures, government purchases, and net exports--are also induced by income and production.
  • Investment is induced by income because an expanding economy generally boosts business profit, which is then used for investment expenditures on capital goods.

  • Government purchases are induced by income because extra income generates more tax revenue (especially state and local tax revenue), which is then used by government to finance expenditures.

  • Net exports, the difference between exports and imports, are induced through imports, which are induced in the same fashion as consumption expenditures. An increase in income is not just used to purchase domestic goods, but also imported goods.
Other components of the macroeconomy are also related to, or induced by, income and production. An important one is saving, which is the other side of consumer behavior. Consumption and saving are both induced by income. The psychological law states that an increase in income is used both for extra consumption and extra saving. A second induced part of the macroeconomy is taxes. In particular, sales and income taxes are directly related to income. More income invariably means more taxes. Another is the demand for money. Because expenditures use money, an increase in income not only induces expenditures, it also induces the demand for money.

<= INDIRECT BUSINESS TAXESINDUCED EXPENDITURES =>


Recommended Citation:

INDUCED CONSUMPTION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: December 11, 2017].


Check Out These Related Terms...

     | autonomous consumption | consumption function | consumption line | marginal propensity to consume | induced expenditures | induced investment | induced government purchases | induced imports | slope, consumption line | intercept, consumption line | effective demand | psychological law | injections | leakages |


Or For A Little Background...

     | Keynesian economics | circular flow | aggregate expenditures | consumption | consumption expenditures | personal consumption expenditures | macroeconomics | household sector | disposable income | national income | gross domestic product | saving |


And For Further Study...

     | aggregate expenditures | aggregate expenditures line | average propensity to consume | derivation, consumption line | derivation, saving line | consumption expenditures determinants | Keynesian model | Keynesian equilibrium | injections-leakages model | aggregate demand | paradox of thrift | fiscal policy | multiplier |


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