Aggregate Consumption

Applied Econometrics model of Aggregate Consumption



Applied Econometrics model of Aggregate Consumption

Introduction

To understand the economic life of a country one must understand the factors that lie behind the consumption. When incomes rise, people want to buy more goods and services that improve their standard of living (clothing, housing, auto recreation, health and education etc.). Consumption depends largely on the time and when consumption increases in the short run it helps to grow the production and employment rapidly. Similarly, when consumption increases in the long run greatly influences the growth and economic prosperity. The consumption is dealt in both microeconomics and macroeconomics but the aggregate consumption. The importance of aggregate consumption in macroeconomics is for two reasons. First, the aggregate consumption is used for analyzing the aggregate savings of an economy and secondly on the basis of aggregate consumption analysis we can predict the investment through the savings proportion. The aggregate consumption function is the macroeconomic relationship that exists for the whole economy between aggregate consumption and aggregate disposable income. There are two main causes for the movement of the function i.e. variations in disposable income and expected aggregate changes in wealth.

Literature review

In macroeconomics, there are two very important school of thoughts without which macroeconomics is incomplete. First is the classical and the other is he Keynesian school of thought. The literature review will completely depends upon their theories and results for aggregate consumption that we'll further use in our analysis.

Keynesian theory of Aggregate consumption

According to the general theory of Keynes, there are some social forces that determine the amount of the expenditure side of the objective factors of subjective factors. Among all these socioeconomic factors, income is the most important factor that determines consumption, assuming other factors as stable or constant data (Romer, 2001).

The Keynesians are interested in the functional relationship being established between aggregate consumption in real terms and real income for the period from the fundamental psychological law of Keynes which is stipulated as follows: "when income increases in an economy, its aggregate consumption increases but also an amount less than income growth" (Barro, 1997).

Classical Theory for Aggregate consumption

The major difference between Keynesian and classical are that classical do not want the interruption of government and that is why their consumption is self regulating according to the increase in income (Cass, 1965). In Keynesian, the government interrupts for increasing the consumption according to its fiscal policy and that is why the interest rates and inflation is a major concern of control in Keynesian while in classical mechanism the interest rates are not determined which certainly affects the aggregate consumption in comparison with the Keynesians (Barro, 1997).

Theory

The aggregate consumption refers to the costs of consumption or final household consumer units. From the macroeconomic point of view we are not interested in determining what types of goods consumed, or who just consume, but what determines the overall consumption of society (Romer, 2001).

Determinants of aggregate consumption

The aggregate income

The level of disposable income is the main determinant of household aggregate ...