Keynes’ Psychological Law of Consumption Function
Keynes’ Psychological Law of Consumption Function was proposed by J.M Keynes which forms the basis of the consumption function. It explains the nature of the propensity to consume schedule. The law states that people have a tendency of spending less proportion of increased income on consumption because a part of income is saved.
The law is based on the following propositions:
Proposition I: When aggregate income increases, consumption expenditure also increases but by a smaller amount. It is because as income increases, people are able to satisfy their wants side by side so that the need to spend more on consumer goods diminishes.
Y ↑ → C↑ But C<Y
Proposition II: the increased income will be divided in some ratio between consumption and saving. This proposition is followed from the first proposition because when the whole of increased income is not spent on consumption, the remaining is saved. Hence, consumption and saving together.
Y → C+S
Proposition III: Increase in income always leads to an increase in both consumption and saving.
Y ↑→ C ↑ S↑
Schedule
| Income (Y) | Consumption (C) | Saving (S =Y-C) |
|
0 |
40 | -40 |
|
100 |
120 |
-20 |
| 200 | 200 |
0 |
|
300 |
280 |
20 |
|
400 |
360 |
40 |
Proposition I: Income increases at each stage by Rs 100 crores, consumption increases at each stage by Rs 80 crores. Thus, when aggregate income increases, aggregate consumption also increases, but by a somewhat smaller amount.
Proposition II: At any two consecutive periods, ∆Y = 100, ∆C= 80, ∆S = 20. Hence, the increased income of Rs 100 crores in each stage is divided into some ratio between consumption and saving. Hence, increased income is divided into consumption and saving.
Proposition III: As income increases from Rs. 200 to 300, 400 and 500 crores, consumption increases from Rs 200 to 280, 360 and 440 crores, along with the increase in saving from Rs 0 to 20, 40 and 60 crores, respectively. Hence both consumption and saving increase with an increase in income.
The psychological law of consumption can be explained with the help of figure:
In the figure, when income increases from OY0¬ to OY1, Consumption also increases from EY0 to C1Y1, but the increase in consumption is less than the increase in income, i.e., C1Y1<CY. Similarly, when income increases from OY1 to OY2, consumption also increases from C1Y1 to C2Y2 and increased saving A2C2>A1C1.
Assumptions of Keynes’ Psychological Law of Consumption Function.
1. This law is related to the short-run because in the short-run distribution of income, price level, population growth, fashion, tastes, behavior, etc., won’t change. Consumption will only depend upon income.
2. There should be a normal situation in the economy for the application of this law. In such a situation, war, revolution, hyperinflation, etc., should not occur.
3. It assumes the existence of a laissez-faire capitalistic economy. It means, this law only operates in a developed capitalistic economy where there is not any kind of government interference. That is, this law won’t be applicable if government intervention occurs.
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