Adobe Scan consumption function managerial economic

consumption function shows the relationship between aggregate consumption and disposable income, indicating that as income rises, consumption also rises but by a smaller amount. The most common linear form is \(C=a+bY\), where 'C' is consumption, 'a' is autonomous consumption (spending even with zero income), '\(b\)' is the marginal propensity to consume (MPC) (the proportion of extra income spent), and 'Y' is disposable income.

1. CONSUMPTION FUNCTION

CONSUMPTION

made on the direct satisfaction «

1d services 50 as to satisfy our w
may be termed as.
tS are production, exc

is. Consumption is the econor
the starting point of various economic activities. The other econo
y ange and distribution, Producers produce goods according
A ea del
es Of goods are distributed among the four mely land, labour, capital a
Peur in the form of re ', wages, interest and profit respectively. These are the ince
far factors of production, This incon a again spent on consumption. Thus consumption is
‚nd end of economic activities If there is no consumption, then there is no production, exch
feribation. Thus the consumption patterns in an economy are very important in determinin;
fowth and development of the ‘economy,

CONSUMPTION FUNCTION

‚The aggregate consumption in an economy depends upon a number of factors namely nations
= Face level, fashions, tastes and habits ete. However, keeping other thi
ion depends on income. In other words,
C=f(Y)
© = Aggregate consumption
Y = National income
‘The above function is monotonicall

ly increasing function, which means that as income increases
fon also increases. An increase in income never leads to decrease

Feisty to consume

aa ern propensity to consume we mean the ratio of

ing to Kurihara,

consumption i

in consumption than

aggregate consumption to aggregate
Consumption represents the amount of consumption expenditure

3 €
OT income, whereas the propensity to consume

is a schedule of consumption

Propensity to consume is very important for an economy
the people in the economy are spending a small portion o!

277

2. gr ur
consumPTION on of our wants. W

satisfacti
; ption is the econom
The other econom

the direc

ade 0!
y our wa

Consum
activities
sods a

aditure mM

Services so as 10 satisf

ing point of various econ

‚d distribution producers
ed in t

rs of production

ants
nomic
produce §
he market and lastly the
» namely land
tively. These
fus consumpt
suction. exchang
£ in determining

the ext

mean

ccording K
proceeds from
labour, capital and

incomes
e start

By consumption we

¡sume various goods a
tivity which may be termed as the sta

jvities are production, exchange en
D. These goods are then exchans
Ges of goods are distributed among the four facto! x
scorn te form of rent, wage, Interes! A profit respec
Gr factors of production. This income is again spent on consumption. T
end of economic activities. If there is n° WF peumption, then there is NO prod
rbution. Thus the consumption patterns in 41 y are very importe”

jowth and development of the economy:

CONSUMPTION FUNCTION

‘The aggregate consumption in an economy depends upon a number of factors namely
fashions, tastes and habits etc. However, keeping other things as constant.

some, price level.
Is on income. In other words, consumption is à function of income.

-asumption depend!
c=f%)

Where C = Aggregate consumption
Y = National income

er el increasing function, which means that a

ad \creases. ‘crease in income never leads to decrease in consumption than

open to Consume =

By the term

propensity to consi

m ume we mi io of

According to a pepe ne een the ratio of aggregate consumption to aggregate
Kurihara presents the amount of consumption expenditure

given
E | of income, wher
u reas the propensity to consume < is a schedul
% is a schedule of consumption

nd

of

‚sumer's nex

me

national

income increases,

levels of à
income.” Propensi
5 a
e ican cl er eh to consume is very important for an economy.
that ple in the economy are spending a small portion of

277

3. jon and a high
le | of economic activity. The

and hence a low le owth and de

Swever a higher level of Propensity to conan +

ON A!
DEFINITIONS OF CONSUMPTI ND

imption is the direct use of goods and

In tx words of Meyers, °C

the human wants

à coran 10 Nicholson, “Consumption is the act of using good an
eurent wants.”

5 Inte words of Peterson, “Consumption function may be defined as à
ros that il be spent for consumer goods and services at differen

à According to Brooman, Consumption function shows what expen.
‘ish to make on consumers goods and services at each possible eve! y =

S Dernburg and McDougall say, “The schedule that relates consumption

income is called the propensity o consume or consumption function

At zero level of y 7 Og
Consumption which ms, Osumpton is not zero, but 20. This À 8
O as for subsistance, This is alo te 44%
either past savings re Of the level of income. This con“!

a

4. emotion

sel.

E AS in
come
Mere; > e, when
"Sein in Imption also inreass. Tere i ota single IME
incre income ental oies
icons wel i"
than no" ncrass, consumo also increases, But incre in consumption is less
a arc xan E
ncome

Increases as 20, 100, 180,260. le, Thus whl

etc, but consun
‘Thus change in consumption

by 100, cons

erect y 1 om M
AC < AY

4. Whatsoever income is not consumed i sv. a

ee His nption. In the start, when income is zero, savings is -20, LS there are

la ings. At 100 level of incom ent to satisfy consumption and savings

re zero. After this, there are posit .. As income increase, Savings also increase,

however increase in savings is less than the increase in income.
AS<AY
and savings. Income is taken,

Figure I shows the relationship between income, consumprion

me X-axis, whereas consumption and savings re taken los FORE “The 45° line shows the
1d consumption. T ¡e entire income is spent on

malty between income an
function would =

sumption, the consumption
slike the line represented by the AS line
'C is the ordinary

‚This line stats not from

"En. bat at some positive point C. OC i he
sistance consumption level, Le.
1 of income. The

Tine CC slopes upwards, showing
>, consumption also

‘of CC line is less than
ac < AY. At

inen
is less

ys is the difference between

line shows th

core À poo Kinds E
pro rage mal to 0
sun

5. [200 ee average propensity to Consume is the

1. Average propensity to consume =
aggregate consumption o ARTE
c

APC= y

suppose in an economy, national income is © 1000 ers. and consumption expe
pose in y
270 cs. APC in this case will BE
700
= 07
APC :006 a
is means that 0.7 par of total income i

con consumption.

spent on consumption, ie. 70% incomeis

ine | at aspecfied evel of income. is the proportion of a given income

peat for consumption purpose.”
2 Inthe words of Kurihara, “The average propensity to consume is the ratio of cons
‘xpenditure to any particular level of income.”

6. From Table
1

IL, we observe the following important features of APC
APC is always positive

2. APC falls with the level of inco the short run),

3. Mostly APC is less than unity, This is beca

ofthe fact that apart of income i spent on
consumption and mostly C < Y. However, for lower levels of income, consumption can be
more than income and APC can be more than unity,
APC is also expressed
tically as shown in Figure 2.
is figure, income is taken along
and consumption along Y-axis. CC
‘consumption curve. To find APC,
point on consumption curve, we
Chy Y.

APC at point A, is:
Consumption OC,
~ income oY,

APC at point B, is
Consumption _ OCz
ee _ a
income À

As consumption and income, both are positive APC remains postive 3
2 Marginal Propensity to consume :~ Marginal propensity to consume
‘change in consumption to change in income.
AC
‘MPC = W

Séppose in an economy, the initial level of income is Chem
is € 60 crs, Let the income rise 10 120.1 and coms

£10 crs. Thos,
This change in income is €20 ers, while the change in comunion Y
MC wit be:

the rato of

100 crs and the initial evel of
cn

isC,

Jevel of income, consumpton

7. ‘Thas in alinear consumption function of the type C= a + BY, bis.

MPC. Its the
consumption curve, Mathemat

ically, MPC can be found by differentiating the con

0
10
20
30
40
509
on
200

8. _
tant change in income, there is

From this table we obs un: ges
it features of MPC à

1, MPC is always positive
2. Itis less than unity
It remains constant for a straight line
on curve or linear consumption function.

consumption curve,

Ac _ SC,

in properties of MPC are as follows :-
always postive :- Both income and consumption move in the same direction

that ifincome increases, consumption increases and if income fal, consumpace
[MPC being the ratio of change in consumption to change in income Wil thus

Positive,

Misis
ny a pain

and 1 := MPC always lies between Oand |
increases, consumption lso ines HH
sumption. So MPC lis beeen ad !

9. Also MPC>0
Hence 0<MPC<1
[MPC falls with increase in income :~ Generally when income levels in the
rise, people tend to consume a smaller percentage oftheir income on consumption
rather increase thei savings. This is because of the fact that many of their consumpa
needs had already been fulfilled.

‘MPC of poor communities is higher than the rich communities :- Poor comm:
have low levels of income, Most ofthe increases in their income are spent to satisfy
consumption needs. Thus their MPC is high. On the other hand, the rich comm
already enjoy a higher standard of living. Any additional increase in their income:
savings and thus their MPC remains low.

‘MPC is stable in the short run :- MPC being a psychological concept remains
‘in the short run, because the psychological factors remain same in the short period.

Average propensity to consume isthe rato of total consumption to total income.
S
ARC= y

Marginal propensity o consume, on the other hand, is the ratio of change in
10 change in income.
ac
ay
{othe shor run linear consumption function,
C=a+bY,
‘APC falls with the increase in income,
Mm APCS eso In income, bras MPC reine coi
Yo e Long ru consumption function,
Cab
APC = MPC
Dein Jong rn, bah APC and MPC a ‘Constant and are

MPC =

qual to cach oh

The can been go

Pro siga saan ‘He consumption and aggregate income can take various
1. Short run

from he pi oo Keay Te Sort un consumption curve does

1» some positive point on Y-axis showing (3

a, ——

10. erre consumption even al zero leve of income, Shor run consumption function farther

of wo es
a) Short run near consumption function

“The short ron linear consumption function takes the form
C=a+bY
Were C2 aggregate consumption
Y= level of income
2 autonomous consumption ie, consumption a ze level of ncome
= slope of consumption curve
“Here the slope b is fixed. In technical term itis called marginal propensity fo consume
fur 4, CC is the consumption curve which starts from the point C on Y-axis. The angle
ch CC makes with X-axis is less than 45°.
Tofind MPC, differentiate equation (1) wt Y
ac
Tar
To find APC, divide equation (1) by Y

MPC: b

© Consumption

constants, The above i» à quella
‘income (Y), the change in C O*

11. Business Economics B.Com(py
pa ye
CAN

E APC= y +b 4eY

MPC can be found by differentiating equation (2) wart Y

N
MRC = SY =be ey

Hence in non-linear consumption function,
‘either APC nor MPC is constant, but a
function ofthe level of income (Y).

The shape of non-linear consumption
functions shown in Fig, 5

‘The consumption function, here takes the
shape of a curve instead of a straight line,
Long Run Consumption Function OR
Proportional Consumption Function
In the long run consumption expenditure
is proportional t the level of income. The
consumption function inthis case is given as

o Consumption

smption curve stats from the point of engi
‘rsh line making an angle with X-axis which y less than 45°, This is show i
To find APC, divide equation (3 by y
€
Ace Se
yoo

To find MPC, ferne equa

Oway
mpc. % =b
av
Hac te bong tun
AC = Mae
ms À
So es lat ete heen, a pc and MPC are constat
qual 1 cach ee

12. Function SPEED
‘SAVING FUNCTION AND PROPENSITY TO SAVE

Saving function is à fun

¡Saving function is ee

lates aggregate say

peek in an economy tothe ageregate
also rise and vice-versa,

the words of Peterson, “Saving function or

‘amounts that will be saved at different k 2 =

levels of income.”

ity o save is of two kinds =
| Average Propensity to Save
‘Marginal Propensity to Save
Propensity to Save :~ Average propensity o save is the rato between
savings and aggregate income.

s
aad

se in an economy, the level of income is ? 100 crs and level of savings is € 20 es.
thus 20/100 = 0.2.

13. Table IV presents the calculation of APS. In his table, we find that as income ice
savings also increase. APS which is the ratio of savings to incom:
increase in income. This means tha as the level of income rises inthe economy,
are able to devote a larger portion of their income to savings,

Relation between APC and APS

We know that income is divided into two parts, ie. consumption and savings.
ie Y=C+S
Dividing both sides by Y

es,
var
T= APC APS

‘Thus sum of APC and APS is equal to unity,

2. Marginal Propensity to Save :~ Marginal propensity to save (MPS) is the ratio
change in savings to the change in income.
a
AN:

‘Suppose in an economy, income level is 100 ers and savings are & 20 crs, let
ses 10 Y 120 crs and savings rise to 30 crs, Thus the change in income is 7 20

as
the change in savings is Rs. 10 crs, MPs = 4S =
E ay ~ 20

05.

Table V presents the calculation of a Ines
function, MS remain conan Lie com fon he ale Ga in 9

savings is also a psy

14. — ;
RELATION BETWEEN MPC AND MPS ©

Any increment in income is divided into

AY =ac+ as

Dividing bou sides by AY
ay ac as
ay “ay * ay

(PC + MPS.

Thus the sum total of MPC and MPS is unity
—

[0 consume depends on a number of subjective and objective factors
[Secre Factors: Subjective actos ae tos actors which eae othe psychology
Moreover there are many social and institutional circumstances which affect the
levels in an economy. Together these factors are termed as subjective factors. These
10 the feelings and thinking pattems of the society which make the people in the
Whether to consume or save more out of ir income, Keynes gave much importance
[con Sone ofthese are explained as below
Economic Independence : Some individuals want hem oe 1 be economical
on thers at any point of time in their ie. Such people consume less and sao

"eat

ers inthe sense that they ant o bi
estat of Miserness: Some people a ae A
fortunes for themselves. Such people
‘There ae always epoca Of disease, coming of
leas ex, People save a par of her Income (0 mest uch unforeseen contingencies
le sa any people sper es ad avs mor, so Y
Income Inthe Pote: Many pele Wed me
e aid ht a ns
any pretense Bin 1
“Meet unforescen
Negatively
Toleave a For"
“they leaves"

nn.

wt weal früher legal hors ar hei dy

15. i. 4

Business Economics B.Com, y
20 :
BE an pp oe en =
To ey pot Td at delay Dt wether
pa
$. Extension of Business: Business firms save money for the extension oftheir ju

This money is ud for capital formation which lead o extension of business

9. Moderanisation of Business + Business firms save more s0 as 10 install new mx
and plans only to replace the old ones.

10. Financial Prudence : Firms to cam financial prudence always keep asie si

funds. These funds work as a reserve to meet depriciation and obsolescence of
machines

(b) Objective Factors: The objective factors have nothing to do with the syslog)
sing of people. These are the concrete economic factors affecting consumption fn
Propensity to consume, Some of these factors are outlined as below.

"Peston consumption ase the propensity to consume. On the other and.
income is unequal, money is concentrated in the hands of rich people, wbo' ve)
Property 10 consume, Thus the propensity to consume in the community vil
such a case

= ; ge
SSS; coring 10 classical economists, wage cut leads to increas In PO"
Tran ey ewe wages from the supply sido. When wages arre
ict snd Prices all This would lead to increas in consi
pene $e that reduction in wages wil ead fallin pone
un nt income ofthe working class and he ds

ich people, having I er

” 1 low propensity to consum

une of the community fal oan
Gain, ve
iS Wind ais ar he sudden or west
otal pp SY speculation, People end vo spend aL
pe tend wo spend a,

"PERSIty to Consume, arly windfall Ls

a
Fr ep
4 {Change in

“aha ne mM het
“one und
5. Social

n expectation of increase In DT pi
"hold extra stock of goods Thus m

pret icone gee SHA tei asian by wre at
Ce ccna at insurance an a
tran polis, mua

co Sl

16. Consume nesses On the other hand, if the corporation rein ares a
7. Fiscal Policy of the Government : Fi
policy, de distribution of income tends

al policy is the government policy re
re. If government adopts progressive un
{0 be more equitable rising

—_

Propensity 10 consume. The subsidies gi
food also raises propensity to consume.

& Rate of Interest: According to classical conomists savings are a direct fonction of
‘ae of interest. As rae of interest increases, savings increase and consumption fl Bu
amino Keynes, the shor run efecto change in rato intereso indivi pen m
peanut and unimportant. However, in Jong rn, the substantial changes in rate

> Innovation of new products ; When he entrepreneur bring new products the markt
people tend to rase their consumption levels. Today people are crazy about electronic
devices like mobile phones, laptops etc. There is a tendency to change the mobile handsets
S% six months, due to the craze for new features.

10. Stock of Consumer durable goods : If people already possess the consumer durable
200 like sofa sets, TV, air conditioners, cars ec, their propensity to consume will decline

11. Pigou Effect or Real Balance Effect: Prof. Piguou was ofthe opinion thst whew
Prices fall, the real value of cash balances of people rise. As such, they tend 10 spend
‘ore and their propensity to consume ses. Keynes citicid the Pigouelfect. According
10 him, most of the people do not possess cash balances. Even if they posses it, they ten
Lo multiply it instead of spending ¡ton consumption.

12. Availability of Goods : Propensity 10 consume is also affected by the availability of
goods. If there is shortage of goods due to famines, power failures, shortage of row
materials, strikes, lockouts etc, people would not be ale 10 consume the gos they ani
‘and hence propensity to consume may fall

13, Changes in Fashion and Tastes: Fashions and tastes also affect propensity 10 cons
New fashions encourage consumption

14, Past Income : People's consumption is affected not only by present income, but ab by
the pate of past income streams. If they had maintained à higher

‘thus higher level of consumption in the past, their consumption dues 00% fall nesta
ova MH the present income falls. This is because they have acusiomned Ihe Ivc
per endend of iving
15, Demonstration fittest ; Pour people in the rociety us influence by the higher
preparo Abe ich. Whenever they get some sata income, Whey orl
Te uma ich sas Ts sh Uy by sl wer an o
Ws ad te propi to comune nes

ra

vel of ie

A

17. Business Economies B.comp 5
E

16. Instalment and Credit Facilities : When the consumers are y
in instalments, they tend to buy more consumer durable
‘with low rate of interest encourages consumption.

A: Urbanisation and Shopping Malls : Consumption increases with urban.
the needs of urban living are more as compared to the rural
fa variety of goods in modern shoppin,

IR. Credit and Debit Cards: It has been observed that people spend more «
Ari oreredit cards in their hands. Paying cash is always psychologically ps
‘we often seen buying petrol worth 7 200 by cash. The same person may 2
cd 0 capacity when paying through debiveredit card.

| PSYCHOLOGICAL Law oF CONSUMPTION

Psychological law of consumption is an important m

‚en th
goods. Similarly

areas. More
18 malls encourages people to buy

So Ses tat When aggregnte income in an economy incre
‘Sensamption also increase in consumption is less than the incres*
Par‘ of their increased income to savings. In other *
Ama at buta part goes to savings also. In this way inc“ ras
time consumption and savings This nae, Feferred to as Fundamental Law of Ce

is also increased, but not by so 1%

| Assumprions

Ñ aw al coosumpron is based on the following =>”
anis and tnsicusionas Comes : 1%
a ee rn
a Jon ie bed han period ss
un wader normas sonó
+ Ce] Men, Lemnos. Monts cu PU
3 ew oh. cap

pou ue o 88
D

18. 'XPLANATION OF THE LAW

This law can he explained with he help of Table VI and Figure 7 as follows
TABLE VI
N Income QT Consumpiono) | Sin)
o E 00
100 100 0 .
20 "is 20 >
200 20 w
400 wo
500 0 so
600 500 100
200 sso 10

In this table, it is clear that as income increases, consumption also increases. But the ine:
consumption is Less than the irease in income, Income increases a 0, 100,200, 200 —— ete
as, consumption increases as 20, 100, 180,260 -— te, Income Increase by 100, bu
sumption increases by 80. Thus increase in consumption is less than the increase in income. *

Italy consumption is mor thn income is consumption sme cite from pas savings or
me 20. This mini or mb
“sumption required for living.

The difference between income and: consumption is saving. Initially there are negative savings

© > Y). But afterwards there are positive savings, Increase in savings is also less than the
in income,
en 7,income has been taken along X-
bay sutmption, savings along Y-axis. ASis
RS ply ine. Tine is ao known
mike makes an angle of 45° with X-

This
Sa iis ht i a the income is
> y AS would be the consumption line,

Dunas

glo termed as zero savings line
N pts consumption ne is CC This
À et pont Con Ya. Ts
{Piistance consumption i.e

‚eo level of income, $8' isthe
{ting fom à point below origin,

ine At negative savings OS at

19. Business Economics BCom) $,

ease, This is clear from the upm

onsumption and savings in

As income increases, both

sloping consumption and saving curves. At OY level of income, consumption i equa toy
OY _EY. Thus income and consumption are equal at OY level of income. At this point saving
Ax OY, (= PY) level of income, consumption is C;Yj. As C/Yy > Py. consumprim

more than savings. Savings are negative tothe tune of Ÿ 5j. At OY, (= Pa Y) level of
Sowewer, consumption (C¿Y y) is les than income. Savings are PC) or $Y. Thus sa
cher be calculmod from the difference of AS and CC! line or from SS line

An important observation : As the angle which CC! makes with X-axis is less ar 4
‘Store of ine CC! will be less than 1. Slope of consumption curve is termed as MPC. So MPC €
con the whole consumption line CC!

‘There are three main propositions of the psychological law of consumption
1. Increased aggregate income leads to increased aggregate consum;
somewhat smaller amount : As income increases, consumption also increas
increase in consumption is less than the increase in income.
ie AC < ay
[Dividing bos sides by AY

‚ption but by

comics is less than the increase in income, whatsoever is not co
Tun increment in jnccane is divided ino increment in consumption and "*

pen
CAP
neg ta sas dy AY

LL e,
e a a

Vene «Sr >
D. he item le auge lacus I uulily Wo bead citer to le * A

be soci Mae ho | As ca case, nan mm a

mme wt prnl tt no et

Des eg a then

20. Funcion

then AC> Oand AS > 0

295

As
ac

>Oand © >0
Say ay

oe MPC > 0 and MPS > 0
So his proportion implies that both MPC and MPS,

are positive
Combining the above three propositions, we imply that

O< MPC <1

O<MPS <1

and MPC + MPs = 1

IMPLICATIONS OF PSYCHOLOGICAL LAW OF
CONSUMPTION OR IMPORTANCE OF KEYNESIAN
CONSUMPTION THEORY

Psychological law of consumption ian

gra part of Keynesian theory of em
ce of Keynesian theory is made clear from the following points

election of Say' law of Market: Say's lw states that, “Supply creates in 7
demand” This lw is based on ihe asuman tht ter priced ic sun ne
consumed, However scold aw ofonsumption eplinshun MPC à > a
in consumption is less than te increase Production. So this law re
law of market

nployment. T

Pestle of General Over A TS ecg, lo
behind the increase in ing

maton known as savings gap, Due to this
on which further leads tothe pe

explains that consumption lacks
law of consumption explains pi e
there arses a gap between income and cons

s the problem of over product

blem of
unemployment in the economy.
pe af este Ve am ss han isc, th gap 3

| pe ump an ci be ed ons on E
cee sable in te short ru, 010 ring the cn MÍ the problem of uncmpoyin
make more and more Investment, Thun Investment ix very .
we have 10 make in
Keynesian theo

4 Existence

abe 'bily of under em bsumption remains behing
sy teres Soma Which is ess than fu
income, age"

employment

21. 5. Tendency of Declining Marginal Efficiency of Capital : Marginal efficiency of cap)
(MEC) is the expected rate of profit on new investment. As consumption fails to rise,
o stability of consumption function in the short run, the demand for consumer good:
‘There is a fear in the minds of producers regarding their sales. This discourages y

investors and their profit expectations fal. It leads to the decline in the MEC
S As AC < AY, there is a savings gap. As income increases th
also increases. This savings gap is not good for the economy. Due to this gap consum;

remains less than income and economy gets trapped in the problem of over producti
and unemployment,

Necessity of Government Intervension : Classical economists believed that ther

‘no need of government intervention in the economic matters. However keynes hass

Why government intervension is needed to bring the level of full employment in the econ
ings gap can be filled either by consumption or by investmer

government intervension can be very important. Government can pump up the
by investing in infrastructure projects like hospitals, dams, roads etc. It would help infil
the savings gap. Moreover this would also induce the private investment in the eco!

in investment le

‘multiple increase in income. The ratio of increase in income to increase in invest

termed as multiplier. Specifically,

ay
Eu
Where K = Multiplier

AY = Change in income
Al = Change in investment

1
1-Mpc
‘Ths value of MPC determines the value of

For instance, if MPC
income would be

Moreover, K =

plier,

= 05 and char
DS and ch investment is Rs.10 Crore, then

> 1
T=MPC "105 * 05 =?
ay
and y

22. 297

AY = 20
of Rs.20 Cron

So an investment of Rs.10 Crore bings an increase in income to the tune
IF MPC is more, the value of multiplier will be more and the income generated will also be
more, Thus the concept of consumption function explains the unique process of incom

generation in an economy.

9. Turning Points of Business Cycles : In a capitalist economy there are
fluctuations of business activity termed as Business cycles. There are four phases of
Business cycle, namely Boom, Recession, Depression and Recovery. These phases repeat
themselves again and again. Keynes has explained the occurance of trade cycles with the
help of his psychological law of consumption. During boom, income, output and employment
tend to rise. However, rise in income is not accompanied by an equal increase in
‘consumption. So aggregate demand becomes less than aggregate supply. This gives
business cycle a downward tum.
Similarly, when there is depression, income falls, but fallin consumption is less than the
fallin income, because people tend to maintain their old standard of living. As a result
‘aggregate demand becomes more than aggregate supply. The business activity gets boosted
and the business cycle takes an upward tum.

10. Secular Stagnation : Secular stagnation means long run problem of depression. When
increase in income fal to bring equal increase in consumption, the savings gap goes 00
‘widening with time. not cured properly with government intervension, this may result»
the problem of secular stagnation.

11, Policy Implications : Psychological law of consumption has important policy umplic 200:
for the government. One of them is public investment during depression. One anote

‘important policy implication is redistribution of income in favour of poor. Govern
‘ust adopt such policies of taxation and expenditure on public welfare, hat wow! Kos
‘table disiibusion of income: As poor have comparatively higher MPC: ation

income in their favour, would increase consumption in th co
ers of acme end iat th esoo

Dao and WOR! have a

par ol Key esian do) of employment.
pine pre Th las bg, ie

23. Business Economics B.Com R) soy
298

MEASURES TO RAISE THE PROPENSITY TO CONSUME

for an economy. The extent which ance
opens to consume is very important a
ir Lead tothe increase in income depends upon the propensity to consume Hi
tb MiG ge ne a ne men
Teadtahigherinrese in income, Soto ring an economy out of low quilbrium wap rope
Sonsume must se. Following ar the important measures to rise propensity to conga
1. Redistribution of Income: Rich people have al

their MPC is low. On the other hand the MPC

2: Urbanisation: The needs of urban people are mo
sie al colonies an coe one
in he consumption evel inthe economy,
3. Credit and Instalment Facilities ; Consumption ca
‘tel facilities he consumer forthe purchase oor
intern, ACS, washing machines ete, Al en
instalments, people are encourage 1 buy thon
4. Improvement in the ‘Transport and ‘Communication ‘Means : With the i
inthe tanspon falc, the products reach oan
ee in the means of communication tke qu telephone,
Herter 6 0 a their cons
$ New Products: The adven of new produ like LE
propa mobiles 10 replace he simple mabe yess LE
people. Everybody wants 10 replace old technology wi
$. Vs, radio, newspapers, i
© inthe market
tn hs stroma, 6
7. Social Security ; People Inv so CS
Provident fund, insurance policy hemes, FDR ete to secure thet
I the governmer the form of tree medical facili
iT hy i hen ay ea al
‘consumption would rise, YING à Lot for their ure needs and theif
8. Increase

Population: low populate

ars i countries, consumpsion can be i
increasing the ppal Hvar gh soo has many adverse effects
development of the economy

24. is fruitful only in the
[cil ny ne og rn fe rt wen wae eed er
increase inthe productivity of lab es The pic
heed ty of labour. So cost of production rises. The prices o
eee pci demand ls a Een
en a is no real benefit However, in the long run, when increase in
See compiled by ice in abou sy co of rn sr
De ella e o of income in favour
lead to increase in consumption in the economy

10. E-commerce : In today’
+ In today's world e-commerce
ss is very important in rising consumption
cs Now los ening ne nt vaio webs. Pope
e buy in the convenience of their homes he products like mobile phones,
laptops, dresses, shoes, artificial Jewellery so on and so forth

CRITICISM

‚ynesan concept of propensity to consume is cricsed by modem economists like
tand Hutt. They criticise it on the following grounds
Improper use of the word Propensity : According to Hazlit, the word propensity has
‘improperly been used by keynes Propensity refers to tendency and not to the entire
“income spent on consumption. To quote Hazlit, “Ifa doctor, however, buys a house and
house both his residence and hs office, how tis term canbe entered jon the Keynesian
edger as part of doctor's Propensity to consume or a9 investment.”
Truism Keynesian concep hat people do no spend thericome oh ST
oor spend a larger portion of their income on consumida se simple vus
‘already knows. There is nothing new in I for which
According to Hazlitt, “In brief, keynes took a loose truism
into a double er, firstly by atbutinga pression 0
secondly, by making it the basis of a false theory
Empirical Verification : Hazlitt Collected the dat de insane, os
ngs ofthe people of America over the period 14+ $5, Hisempialrst
ie the Keynesian theory. It showed that there 033 in savings
income, Thus empirically the theory failed.
€ eancept + According to Hari explaining t a
Ok provide its precision to explain the relation bete" income af
o the extent of calling this aw 4 ‘Fraud’

+long run : In the short run PS)

sion
that

‘we must give credit 0
that everybody kre
that it simply does not

y, consumption

(his law in mathe!