IN TERMS OF THE CONSUMPTION FUNCTION WHY IF THE GOVERNMENT GIVES A RICH PERSON A TAX CUT THEY MIGHT SAVE IT INSTEAD OF SPEND IT.
BECAUSE ACCORDING TO THE CONSUMPTION FUNCTION,EVEN IF YOU GIVE PEOPLE IN A HIGH TAX BRACKET A TAX CUT THAT SHOULD RAISE THEIR INCOME AND THEY SHOULD, THEREFORE, SPEND THE ADDITIONAL AMOUNT OF MONEY OR MORE OF THEIR DISPOSABLE INCOME?
The consumption function is a simplification of what happens in real life. According to the consumption function, people have the same marginal propensity to consume no matter what their income level. In other words, it assumes I'll spend 80 cents of my next dollar (for example) and 80 cents of every dollar after that up to infinity.
But really, a person isn't going to keep spending at that rate. Eventually, I'll run out of things to buy and I'll start spending a lower percentage of my next dollar.
But the consumption function doesn't capture that -- it's just a straight line.
Consumption function is the relationship between the disposable income of an individual or a household and the total consumption and saving. This function is usually depicted in form of a table or a graph.
No two individual or households in an economy behave exactly alike in terms of their consumption and saving behavior. However, when we look at the general behavior some common patterns emerge.
The total consumption of a person expressed as a percentage of the total disposable income, tends to decrease, and that of saving increases as the disposable income rises. Of course the sum of expenditure plus saving always equal to the disposable income.
When the disposable income is zero, a person still has to spend something to survive, and therefore the actual spending is more than the income. This entire spending, exceeding the disposable income, can be seen as negative spending. As the disposable income rises the expenditure rises also, and the negative saving gets reduced till the income and expenditure reach a break even point where income exactly equals expenses and saving is zero.
When the income is increased beyond this break even point, the expenditure is less than the income. The difference between the two is the saving. The percentage of saving as a percentage of total disposable income increases with the disposable income. At very high income it is possible that almost entire increase in the income is used for saving and very little for spending.
A rich person is thus at a level of income where the saving percentage is high. Thus when the disposable income of a rich person is increased by tax cuts, the chances are that a larger portion of it will be saved rather than spent.