Determinants of Consumption Function

K. Murugan

1. Determinants of Consumption Function by Dr. K. Murugan Assistant Professor Department of Economics Guru Nanak College Chennai-42

2. Determinants of Consumption Function Keynes mentioned two principles like Subjective factors ( endogenous or internal to the economic system) and Objective factors. Subjective factors Psychological characteristics of human nature. Social practices. Behaviour Pattern of Business concerns Social arrangements affecting distribution of income. Material change in the short-run periods except in abnormal or revolutionary conditions. It determine the slope of C curve stable in the short period .

3. Objective Factors ( external factors) Changes in wage level: If rise in wage CF shift upward. The workers higher spending. A cut in WR will reduce CF due to fall in income. Windfall Gains or losses: Unexpected change in stock market leading to gain or loss tend to shift CF upward or downward. In 1925 there was boom in America led to rise consumption spending. Changes in the Fiscal Policy: In the form of taxation and expenditure affect the CF. Heavy taxation affect CF by reducing disposable income. Tt was happen in Second world war due heavy taxation.

4. Change in Expectations: Change in future expectations affect to consume. If a war is expected in future scarcity and rising prices durable commodities. As a result people buy excess of current needs and CF upward. Change in Rate of interest: Changes in market RI influence CF. A rise in RI will lead to fall in the price of bonds, shares leads to discourage consumption. Financial policies of Corporations: Dividend payments tends to CF. Distribution of Income: Large disparities between rich and poor leads to consumption is low. Attitude towards Saving Duesenberry Hypothesis

5. Measures to Raise the Propensity to Consume Income Redistribution Increased Wages Social Security Measures Credit Facilities Advertisement Development of the Means of Transport Urbanisation

6. Theories of Consumption Function Types 1. Absolute Hypotheses 2. Relative Hypothesis 3. Permanent Incomes Hypothesis 4. Life Cycle Hypothesis

7. 1. Relative Income Hypothesis It is developed by James Duesenberry . It affected the consumption function The hypothesis relate to demonstration effect. The tendency of human beings higher consumption level emulate the consumption patterns of one’s rich neighbors. The consumption preference are interdependent. Past Peak income hypothesis- explains the short-run fluctuations in consumption. Community reaches particular level lead to come down lower consumption during recession. It reduce in saving and vice versa.

8. There is no change in CF in short run. Upward or downward movement in CF when income rise or falls during short-run. Exception during abnormal or revolutionary change unusual events like wars, earthquakes, strikes, revolutions, major change in tax structure, 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.

9. 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.

10. 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

11. 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.

12. Critics 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.