A Very Simple Model

Consumption is one very important component of expenditure, perhaps the most important of the four components, but it is only one of them. As we recall from the chapter on measuring national income, income is the sum of the four components,

1. Y = C + I + G + NX

where

C is consumption expenditure
I is investment expenditure
G is government purchases of goods and services
NX is net export expenditures

To keep things as simple as possible, let's assume that investment is a given constant, and G and NX are zero, and there are no taxes. (Of course, the real world is much more complex, but we are going to take it step by step from this unrealistically simple model).

For a specific example, let I = 1000 (billion dollars), and assume the consumption function is

2. C = 500 + 0.7*Y

with consumption and income, again, measured in billions of dollars. Taking equation 1 and substituting 1000 for I and zero for G and NX, we have

3. Y = C + 1000

Now let's see how expenditure and income interact in this example.

Equilibrium in the Example