) Explain Keynes' psychological law of consumption. What are the determinants of
propensity to consume?
Answers
Answer:
Keynesintroducedthe law of consumptionwhichispopularly knownastheKeynesianLaw of Consumption.
According to the law, Asincome increasesconsumptionalso increasesbutata lesserrate thanthe increase inincome.
Withminimumincomewe fulfill ourbasicneedshowever evenwithzero income ourbasicnecessitiesare fulfilledeitherby borrowing or
using our saving,thisconsumptioniscalledAutonomousconsumption.
Whenthe income of a personincreases, consumptionalso increasesbutata lesserrate anda part ofthe income issaved.
Howeverwe see thatasincome increasesby (1000at every stage) consumptionincreasesbutlessthanthe increase inincome and
savingsalso increases.
Initially there isnegative savingsbutasincome increases, savingsalso increases.
The two importantpropertiesofthislaw isthat:
Asincome increasesconsumptionincreasesbutata lesserrate thanincrease inincome.
Asincome increasessavingsincrease andanincreasing rate.
TWO BASIC PROPERTIES OF KEYNESIAN CONSUMPTION FUNCTION - DEFINITION
The two basicpropertiesof KeynesianConsumptionfunctionis:
Asincome rises, consumer spending willrise.
However, spending will increase ata lowerrate thanincome.
Explanation:
Determinants of the Consumption Function
Keynes mentions two principal factors which influence the
consumption function and determine its slope and position.
They are (i) the subjective factors, and (ii) the objective
factors.
The subjective and objective factors are discussed below:
Subjective Factors: Keynes‟s subjective factors basically
underlie and determine the form (i.e., slope and position) of
the consumption function.
A The subjective factors are the psychological characteristics
of human nature, social practices and institutions, especially
the behaviour patterns of business concerns with respect to
wage and dividend payments and retained earnings, and
social arrangements affecting the distribution of income.
There are two motives of subjective factors: individual and
business.
1. Individual Motives: First, there are many motives “which
lead individuals to refrain from spending out of their
incomes.”
(i) The desire to build reserves for unforeseen
contingencies;
(ii) (ii) The desire to provide for anticipated future
needs, i.e., old age, sickness, etc.;
(iii) (iii) The desire to enjoy and enlarged future
income by way of interest and appreciation;
(iv) (iv) The desire to enjoy a gradually increasing
expenditure in order to improve the standard of
living; (
(v) v) The desire to enjoy a sense of independence
and power to do things;
(vi) (vi) The desire to secure a “masse de
manoeuver” to carry out speculative or business
projects;
(vii) (vii) The desire to bequeath a fortune;
(viii) (viii) The desire to satisfy a pure miserly instinct.
2. Business Motives: The subjective factors are also
influenced by the behaviour of business corporations and
governments. Keynes lists four motives for accumulation on
their part:
(i) Enterprise, the desire to do big things and to expand;
(ii) Liquidity, the desire to meet emergencies and difficulties
successfully;
(iii) Income raise the desire to secure large income and to
show successful management;
(iv) Financial prudence, the desire to provide adequate
financial resources against depreciation and obsolescence,
and to discharge debt. These factors remain constant during
the short-run and keep the consumption function stable.
B. Objective Factors: The following objective factors are
given by Keynes.
1. Changes in the Wage Level: If the wage rate rises, the
consumption function shifts upward. The workers having a
high propensity to consume spend more out of their
increased income and this tends to shift the C curve upward.
If, however, the rise in the wage rate is accompanied by a
more than proportionate rise in the price level, the real wage
rate will fall and it will tend to shift the C curve downward. A
cut in the wage rate will also reduce the consumption
function of the community due to a fall in income,
employment and output. This will shift the curve downward.
2. Windfall Gains or Losses: Unexpected changes in the stock
market leading to gains or losses tend to shift the
consumption function upward or downward.
3. Changes in the Fiscal Policy: Changes in fiscal policy in the
form of taxation and public expenditure affect the
consumption function. Heavy commodity taxation adversely
affects the consumption function by reducing the disposable
income of the people.
4. Changes in Expectations: Changes in future expectations
also affect the propensity to consume. If a war is expected in
the near future, people start hoarding durable and semi-
durable commodities in anticipation of future scarcity and
rising prices.
Keynes' psychological law of consumption states that as revenue increases the consumption also rises, however at a lower rate than which the income increases.
- With minimal income or even with zero income, the basic needs of people are met either by borrowing or using our savings, this consumption is called Autonomous Consumption.
- It also states that the MPC -marginal consumption propensity and MPS - marginal saving propensity is greater than value zero but less than value one.
- The determinants of propensity to consume are Capital gains, rate of interest, liquid assets, consumer credit etc.