KEYNES CONSUMPTION FUNCTION PROF.
KARAN BHATT
INTRODUCTION
The consumption function, or Keynesian consumption function, is an economic
formula that represents the functional relationship between total consumption and
gross national income.
It was introduced by British economist John Maynard Keynes, who argued the
function could be used to track and predict total aggregate consumption
expenditures.
ACCORDING TO KEYNES
According to Keynes, of all the factors it is the current level of income that
determines the consumption of an individual and also of society.
Keynes laid stress on the absolute size of current income as a determinant of
consumption, his theory of consumption is also known as absolute income theory of
consumption.
Keynes put forward a psychological law of consumption, according to which, as
income increases consumption increases but not by as much as the increase in
income.
UNDERSTANDING
The classic consumption function suggests consumer spending is wholly determined
by income and the changes in income.
If true, aggregate savings should increase proportionally as gross domestic product
(GDP) grows over time.
The idea is to create a mathematical relationship between disposable
income and consumer spending, but only on aggregate levels.
The stability of the consumption function, based in part on Keynes' Psychological
Law of Consumption, especially when contrasted with the volatility of investment, is
a cornerstone of Keynesian macroeconomic theory.
Most post-Keynesians admit the consumption function is not stable in the long run
since consumption patterns change as income rises.
KEYNES MAKES THREE POINTS
First, he suggests that consumption expenditure depends mainly on absolute income
of the current period, that is, consumption is a positive function of the absolute level
of current income.
The more income in a period one has, the more is likely to be his consumption
expenditure in that period. In other words, in any period the rich people tend to
consume more than the poor people do.
Secondly, Keynes points out that consumption expenditure does not have a
proportional relationship with income.
According to him, as the income increases, consumption increases but not in the
same proportion.
The proportion of consumption to income is called average propensity to consume
(APC). Thus, Keynes argues that average propensity to consume (APC) falls as
income increases.
CALCULATING CONSUMPTION FUNCTION
The Keynes’ consumption function can be expressed in the following form
C = a + bYd
where
C is consumption expenditure
Yd is the real disposable income which equals gross national income minus taxes,
a and b are constants, where a is the intercept term, that is, the amount of
consumption expenditure at zero level of income. Thus, a is autonomous consumption.
The parameter b is the marginal propensity to consume (MPC) which measures the
increase in consumption spending in response to per unit increase in disposable
income.
Thus MPC = ΔC/ΔY
CHARECTERISTICS
1) Aggregate real consumption expenditure is a stable function of real income.
(2) The marginal propensity to consume (MPC) or the slope of the consumption
function defined as dc/dY must lie between zero and one i.e. 0 < MPC < 1.
(3) The average propensity to consume (APC) or the proportion of income spent on
consumption defined as C/Y should be decreasing as income increases. From the
relation between marginal and average we know that, when average falls, marginal is
below average. Thus, when the average propensity to consume (APC) falls, the
marginal propensity to consume (MPC) must be lower than the APC.
(4) The marginal propensity to consume (MPC) itself probably decreases or remains
constant as income increases.
FIGURE
ANALYSIS
Since the average propensity to consume falls as income increases, the marginal
propensity to consume (MPC) is less than the average propensity to consume (APC).
The Keynesian consumption function is depicted in above.
In Figure we have shown a linear consumption function with an intercept term.
In this form of linear consumption function, though marginal propensity to consume
(ΔC/ΔY) is constant, average propensity to consume is declining with the increase in
income as indicated by the slopes of the lines OA and OB at levels of income Y1 and
Y2 respectively.
The straight line OB drawn from the origin indicating average propensity to consume
at higher income level Y2 has a relatively less slope than the straight line OA drawn
from the origin to point A at lower income level Y1.
