In an economy where all spending is done by households and individuals, in equilibrium consumption equals disposable income, and savings equals zero
The relationship between current disposable income and consumption is known as the consumption function. The principle of consumption smoothing is captured in a straightforward description of household behavior. Typically, we assume that the consumption function slopes upward but is smaller than 1. Consumption therefore rises along with disposable income but not as quickly. More specifically, we frequently believe that the link between consumption and disposable income is as follows: consumption = autonomous consumption + marginal willingness to consume disposable income.
This type of consumption function means that people allocate extra income between spending and saving.
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