A Drop In Consumption

We want to use the multiplier approach to understand macroeconomic changes. So: what would be the results of a change in consumption? Specifically, what happens if autonomous consumption drops by 500?

In the numerical example we have been using, we have a drop in autonomous consumption from 500 to zero, that is, a drop of 500. Recall, we have a multiplier of =3.33. Multiplying these together, we get the drop in equilibrium income.

Thus a drop of 500 in autonomous spending give a drop of 500x3.33=1666.7 in equilibrium income. Equilibrium income declines from 5000 to 3333.33 (that is, autonomous spending of 1000 times the multiplier of 3.33). Here is a diagram that shows the same thing:

Figure 1: A Decrease in Autonomous Consumption

In the Figure, income is measured on the horizontal axis as before, and expenditure on the vertical axis. The total expenditure line before the drop in consumption is shown in solid green and indicated by the label "C+I." The total expenditure after the drop in consumption is shown by a cross-hatched green line and the label "C'+I." The equilibria before and after are shown by the orange lines. We see the equilibrium before the drop in consumption at 5000, as we did before, and the equilibrium after at 3333.33.

As before, we could express this new equilibrium also in a table.

You may have been wondering why people would decide to cut back on consumption. If you haven't been wondering that, let's think about it anyway. It has to do with the relationship between consumption and saving. Let's spend a little time on that relationship.

Saving and Consumption