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Consumption Is An Increasing Function of Income

definition, Marginal propensity to consumes, determinants of consumption function ( Macro economics)

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Rajesh Lamba
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100% found this document useful (1 vote)
544 views18 pages

Consumption Is An Increasing Function of Income

definition, Marginal propensity to consumes, determinants of consumption function ( Macro economics)

Uploaded by

Rajesh Lamba
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Consumption Function

The amount of money people spend out of national income on


the purchase of the goods and services for the direct satisfaction
of their wants is called aggregate consumption expenditure or
consumption
Consumption is an increasing function of income

Symbolically C= f (Y)
It means consumption is a function of (determined by ) income.
Where, C= consumption
f= function Y= income
Consumption Schedule

It is the tabular representation of various amounts of consumption


expenditure corresponding to different levels of income.
Table 1: Consumption Schedule

Income Consumption
0 20
60 70
120 120
180 170
240 220
Properties of the Consumption
Function
The Average Propensity to Consume: The average
propensity to consume may be defined as the ratio of consumption
expenditure to any particular level of income.


Expressed as percentage or proportion of income
consumed.

APC= C/Y,
 For example, if total income is Rs 500 crores and
total consumption is Rs 200 crores,
APC 

200/500
or0.4
Marginal Propensity to Consume
It is defined as the ratio of change in consumption to the change in
income.
 It is the rate of change in APC.
 MPC= ∆C/ ∆Y.

Example

Suppose you receive a bonus with your paycheck, and it's

Rs 500 on top of your normal annual earnings. You
consumption
suddenly haveis anRs500
increasing
more function of income
in income thanand
youitdid
increases by less than
before.
the increase of income.

If you decide to spend Rs400 of this marginal increase in
income on a new business suit, your marginal propensity
to consume will be 0.8 (Rs 400 divided by Rs 500).
Characteristics of MPC
• It is always positive
• MPC is greater than zero but less than one.

because the total increase in income is not consumed a


• part of it is saved. Thus this characteristic can be
symbolically stated as 0<MPC<I where MPC is always
positive but less than one.
•MPC of poor class is higher.
•Constant MPC in Long period: it means that change in
income followed by change in consumption almost in same
ratio.
•Falling MPC in short period: it means ratio of increase in
consumption in short period is less than increase in income.

5
RELATION BETWEEN MPC AND MPS
• Y =C + S
• or
• ∆Y = ∆C + ∆S
• By dividing both sides by ∆Y, we get:
• ∆Y/∆Y = ∆C/∆Y = ∆S/∆Y
• or
• 1 = MPC + MPS
• Example: Suppose a man’s income increases by Rs 1. If out
of it, he spends 70 paise on consumption (i.e., MPC = 0.7)
and saves 30 paise (i.e., MPS
• = 0.3) then MPC + MPS = 0.7 + 0.3 = 1.
The Average Propensity to Save (APS)
• The average propensity to save is the ratio of total
savings to total income. Thus,
S
APS 
Y
where, S = saving and Y = income.
The Marginal Propensity to Save (MPS) Marginal
propensity to save is the ratio of change in saving
to change in income.
MPS Y
S
We know that MPC + MPS = 1. Therefore, MPS =
1- MPC or

8
Psychological Law of Consumption
• The law propounded by Keynes on the
relationship between aggregate consumption
& income called Keynes Fundamental Law of
consumption. According to this law, when
income increases, consumption also increases
but increase in consumption is less than
increase in income. In other words,
MPC( Marginal propensity to consume is
always positive but less than unity.)
Assumptions
• It assumes a constant psychological & institutional complex
which means that income distribution, tastes, habits, social
customs, price movements, , population growth, etc remain
constant& consumption depends upon income.
• It assumes the existence of normal conditions. The law
doesn’t operate in abnormal conditions like war, revolution, or
hyper inflation.

• It assumes the existence of lassiez- fare capitalist economies


& is in operative in case of socialist economies.
Table: 2
INCOME(Y) CONSUMPTION (Rs in Crore)
(Rs in Crore) (Rs in Crore) SAVING
)
0 50 -50
C)
0 50 20 75 -20 -25

60100 70 100 -10 0

120
150
120125 0 25

200
180 170150 10 50

250
240 220175 20 75

300 200 100


300 270 30
Propositions of the Law
It is evident from the above table & figure that there are 3
 main propositions

•When Income increases, consumption expenditure also


increases but by a smaller amount. Thus, it increases less than
proportionately.

•3.The increased income will be divided in some proportion


between consumption expenditure and saving.
4.•Increase in income always leads to increase in both
consumption and saving.
5.
Determinants of Consumption Function
Subjective factors ( are those factors which relate to psychological
characteristics of human nature & social practices & institutions.
 These factors relate to the circumstances when business institutions
would consume less & save more.
Individual factors: • Business Factors
•Foresightedness(some people

• save in order to fulfill their anticipatedExtension of Business.
• future needs. • Liquidity preference.
•Economic independence( some • FinancialPrudence.
• save so that they may not depend on
others financially)
• Modernisation.
•Enlarged income in future.
•Occupational motive.
•Miserliness.
•Precautionary motive
•Status in society.
1.
Objective Factors
Changes in Money income( when income increases consumption
also increases.
2. Change in Real income.
3. Windfall Gains or losses.
4. Change in distribution of income.( if equal distribution of
income, propensity to consume will be more.
5. Changes in the Fiscal Policy.
6. Change in Expectations( in war or shortage of goods people
increase consumption..
7. Change in Rate of interest( If Rate of interest is more , people
save more & consume less & vice versa).
8. Financial policies of Corporations.
9. Attraction of new products.
10. Changes in fashion & tastes.
11. Attitude towards Saving
Measures to raise the Propensity to
Consume
• Redistribution of Income.
• Increased wages.
• Social
 security measures
• Credit

facilities
 Social Security Measures
• Advertisement
 Credit Facilities
• Development
 t of means of transport
• Urbanisation.

 Urbanisation
• Increase in population.
Cyclical & Secular consumption Function
• Psychological law of consumption states that when income
increases, consumption also increases but by less than
increase in income. It means that increase in income is
followed by decrease in marginal & average propensity to
consume. To verify this law, factual data was collected which
concluded that this law is applicable in short run , not in long
run. in order to know the real nature of propensity to
consume, we must study both short run & long run
consumption function.
• Cyclical consumption function(Short run)
• Secular Consumption Function(Long run).
Cyclical Consumption(Short run consumption
function)
• According to Lord Keynes, following relations are found
between income & consumption in short period.
1. No proportional relationship between consumption & Income:
upto a limit consumption expenditure is more than income,
after that limit, it is equal to income & subsequent to that as
income goes on increasing consumption expenditure goes on
diminishing. C= Co+bY
• C= consumption, Co= Autonomous consumption(such a
consumption, when income is zero), b=MPC, Y= Income).
2.Declining MPC & APC.
3.APC is greater than MPC.
These statistics confirmed that short run consumption function is
non-proportional.
Secular consumption ( Long run Consumption
Function)
• Relationship between income & consumption over a period of
about 100 yrs or more is called long run or secular consumption
function. Secular consumption function has following features:
1. Proportional relationship between C & Y: It implies in the long run,
consumption changes in the same proportion as change in
income. C= bY, it means there is no autonomous
consumption(Co) in the long run. There is constant relationship
between C & Y.
2. Constant APC & MPC: there is no fall in Average & Marginal
propensity to consume in long run.
3. APC & MPC are equal.
In long run, at each level of income people tend to consume a
constant fraction of it.

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