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1. Consumption Function The consumption function implies the functional relationship between the level of consumption expenditure and the level of income. Mathematically, C= f(Y) where C= consumption expenditure f=function, Y= income

2. To identify the autonomous and induced consumption , it is expressed Mathematically as : C= a+bYd Where ; a=autonomous consumption b=Marginal propensity to consume Yd =disposable income Since Yd =C +S So, S= Yd -C Or S= -a +(1-b) Yd It can be explained with the table:

3. Income (in Rs.) Consumption C = 50+0.5Yd Saving (in Rs.) S = Yd -C 50+0.5*0=50 -50 100 50+0.5*100=100 200 50+0.5*200=150 50 300 50+0.5*300=200 100 400 50+0.5*400=250 150

4. When income is zero, consumption cannot be zero, consumers will have to borrow or use their past savings. Thus, when income=0, S<0.This is called dissavings . As income increases, savings also increase.

5. DISPOSABLE INCOME Consumption

6. APC & MPC Since, consumption is the function of income and propensity to consume shows how much income is consumed . Therefore, Consumption function can be explained through Average Propensity to Consume (APC) and Marginal Propensity to Consume (MPC) Average Propensity to Consume ( APC) :– ratio of total consumption expenditure to total income APC = C / Y i.e. Consumption / Income For instance, C = 60,000, Y = 1,00,000 APC = 60000 / 1,00,000 = 0.6 or 60% I.e , Household spends 60% of its income on consumption

7. Marginal Propensity to Consume (MPC )– Ratio of change in consumption to change in income MPC = ∆ C/∆ Y i.e. Change in Consumption / Change in Income For Instance , change in C = 60,000 to 1,00,000 & Y = 1,00,000 to 2,00,000 MPC = 40,000 / 1,00,000 = 0.4 or 40%

8. Properties of MPC: MPC is greater than 0 and less than 1. 0‹MPC‹1 Poor people have higher MPC and Rich people have lower MPC. MPC in short run is stable because psychological factors/ institutional factors do not change in short run.

9. Relationship between APC and MPC APC is the ratio of consumption expenditure to income level whereas MPC is the ratio of change in consumption expenditure to change in income level. APC=C/Y MPC=∆C/∆Y When consumption function is linear, as income increases, APC falls and MPC remains constant. When consumption function is non-linear, as income increases, both APC and MPC fall but MPC falls faster than APC. APC=1-APS MPC=1-MPS

10. APS & MPS Counterparts of APC & MPC are APS & MPS APS – Average Propensity to Save MPS – Marginal Propensity to Save APS = S / Y (S = Savings, Y = Income) MPS = ∆S/∆ Y (Change in Savings / Change in Income) APC +APS = 1 and MPC + MPS = 1 Rich people have more of MPS compared to poor MPC will be greater than MPS Consider the table:

11. Keynes’Psychological Law of Consumption Keynes’ psychological law of consumption provides foundation to consumption function.

12. This law is based on following propositions Proposition 1: When aggregate income increases , consumption expenditure also increases but by a smaller amount. It means: ∆ C<∆Y Where; ∆ C = change in consumption ∆Y = change in income Proposition 2: The increased income will be divided between consumption and saving ie , ∆ Y = ∆ C + ∆S Proposition 3: When income increased both consumption and saving also increase.

13. Assumptions No change in factors like desire, behavior, fashion, population etc. No government intervention(capitalist economy). Normal situation in the economy( no war, natural disaster etc ) No change in price etc. Consider the table:

14. Table indicates that when income is zero, consumption is more than zero i.e equal to dis-savings. As income increases consumption also increases but less than increase in savings.

15. Importance/Implication of Psychological law of consumption Makes Say’s law invalid Need for Government Intervention Existence of Underemployment Basis of theory of multiplier Nature of Marginal Efficiency of Capital

16. Determinants of consumption Function 1. Subjective Factors (endogenous/internal factors) Psychology of human nature According to Keynes, the psychological factors determine the slope and position of consumption function. Human values, social practices etc. affect consumption. People want to reserve for unseen contingencies, future need, enjoy enlarge future income from investment, be independent, to possess power and dignity, to carry speculative activities, to satisfy miserly nature. II. Institutional Arrangement: Desire to expand business, Liquidity, Demonstrate successful management, financial care etc.

17. 2 . Objective Factors (exogenous/external factors) Change in wage and price level Distribution of income Windfall gain and loss Fiscal policy Changes in expectations Financial policies of organization Holding liquidity assets Stock of wealth.