In the equation constructing the GDP ( Y = C + I + G + NX ), the "C" stands for consumption. The consumption variable refers to expeditures made by households on goods and services produced both in the U.S. and abroad.
Household spending comprises about 70% of the GDP. It's a very important variable. The study of consumption is largely the domain of microeconomists. Many factors determine the consumption number, not the least of which is optimism. How bright does the future look to the consumer? Macroeconomists are only concerned about consumption as a whole and not why households choose as they do.
Determining consumption is easy, it's a function of disposable (after tax) income. You can arrive at this figure by following these three steps..
First you begin with the total income in the economy. This is referred to as "Y". Total expenditures equals total income because one man's income is another man's expenditure.
Next figure out how much tax is paid by everyone as a total. Let's say, for the sake of simplistic argument, that the only tax we are encumbered by is income tax. Now let's say that income tax is 20 percent (if only!). Then t=0.20
So far T=t*Y
Now subtract the taxes (T) from income (Y) to figure out after tax income. This is what's known as disposable income and written algebraically it is
YD
The equation for subtracting taxes from income (and determining disposable income) is this...
YD = Y - T = Y - t * Y = ( 1 - t ) * Y
Consumption is a function of disposable income and a couple of other variables: Co and c.
c refers to marginal propensity to consume or MPC. It ranges from 0 to 1 (never more or less). It indicates the rate you burn through money instead of saving it. For example if c=.8 then 80 cents of every disposable income dollar is consumed and 20 cents is saved. What determines c? It's can be determined by a limitless number of issues and once again that is left to the realm of the microeconomist.
What then is Co? If people have zero disposable income they will still spend. How ? Savings!
Our final equation to determine consumption is ....
C = Co c * YD