Consumption Function
It is a functional relationship between two aggregates i.e., total consumption
and National Income. Consumption is an increasing function of income
Symbolically C= f (Y)
Consumption Schedule
It is the tabular representation of various amounts of consumption expenditure
corresponding to different levels of income.
Table 1: Consumption Schedule
Income Consumption
0 20
60 70
120 120
180 170
240 220
Properties of the Consumption Function
The Average Propensity to Consume: The average propensity
to consume may be defined as the ratio of consumption
expenditure to any particular level of income.
Expressed as percentage or proportion of income consumed.
APC= C/Y
APC declines as income increases because the proportion of
income spent on consumption decreases.
APS = 1- APC
Marginal Propensity to Consume
It is defined as the ratio of change in consumption to the
change in income.
It is the rate of change in APC.
MPC= ∆C/ ∆Y.
MPS=1-MPC
Significance of MPC
Over the long run APC and MPC are equal and approximate 0.9.
MPC is assumed to be positive and less than unity which means that
consumption is an increasing function of income and it increases by less than
the increase of income.
Economic significance of the MPC lies in filling the gap between income and
consumption through planned investment to maintain the desired level of
income.
Keynes’s Psychological law of Consumption
This law says “that men are disposed as a rule
and on the average to increase their consumption
as their income increases but not by as much as
the increase in their income”.
Three related Propositions
3. When Income increases, consumption expenditure also
increases but by a smaller amount. Thus, it increases less than
proportionately.
4. The increased income will be divided in some proportion
between consumption expenditure and saving.
5. Increase in income always leads to increase in both
consumption and saving.
Table: 2
Income( Y) Consumption( Savings (S)
C)
0 20 -20
60 70 -10
120 120 0
180 170 10
240 220 20
300 270 30
Assumptions
It assumes a constant Psychological and
Institutional complex which means that income
distribution, tastes, habits, social customs, price
movements, population growth,etc remain constant
and consumption depends on income.
It assumes the existence of normal conditions. The
law does not operate in abnormal conditions like
war, revolution or hyperinflation.
It assumes the existence of lassiez-Fare Capitalist
economies and is in operative in case of socialist
economies.
Determinants of Consumption Function
Subjective factors ( endogenous or internal to
the economic system).
2. Psychological characteristics of human nature.
3. Social practices.
4. Behaviour Pattern of Business concerns
5. Social arrangements affecting distribution of
income.
On the basis of above characteristics there can
be individual as well as Business Motives.
Objective Factors
1. Changes in wage level.
2. Windfall Gains or losses.
3. Changes in the Fiscal Policy.
4. Change in Expectations.
5. Change in Rate of interest
6. Financial policies of Corporations.
7. Distribution of Income
8. Attitude towards Saving
9. Duesenberry Hypothesis
Measures to raise the Propensity to Consume
Income Redistribution
Increased Wages
Social Security Measures
Credit Facilities
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Development of the Means of Transport
Urbanisation
Theories of consumption Function
Relative Income Hypothesis is given by James Duesenberry.
Based on two assumptions:
A) Consumption behaviour of an individual is not independent
but interdependent on other individual.
B) Consumption Relations are irreversible and not reversible in
time.
According to Duesenberry human beings not
only try to keep up with joneses but try to
surpass the joneses which shows that
consumers’ preferences are interdependent.
Rich people will have a lower APC and poor
people will have higher APC but in long run
APC will remain constant.
According to Duesenberry it is harder for a
family to reduce its expenditure from a higher
level than for a family to refrain from making
high expenditures in the first place.
• The outcome of this statement is that as income falls
consumption declines but proportionately less than
decrease in the income because the consumer
dissaves to sustain consumption.
• Duesenberry combines his two related hypothesis in
the following form
Ct/ Y t = a-b Yt /Yo
Where C --- Consumption
Y--- Income
t ----Current time period
o ---- Previous Peak
a ---- positive autonomous consumption
b---- Consumption Function
• In this equation, the consumption income
ratio in the current period is regarded as
function of ratio of current income to the
previous peak income.
• Ratchet effect is a peculiar phenomenon
observed in this case. The short run
consumption function ratchet upwards when
income increases in the long run but it does
not shift down to earlier level when income
declines.
Criticism
Proportional relationship between consumption and
income is not always true.
It neglects other factors that influence , consumer
spending such as asset holdings, urbanisation,
appearance of new products, etc.
Expectations and level of aspirations also play an
important role in consumer spending.
