Consumption Function

CONSUMPTION FUNCTION
MEANING :
It refers to the functional relationship between household
consumption and gross national income. Mathematically,
Income Consumption
C = f(Y)
100 50
Where, C = consumption & Y = income 200 80
350 150
 Consumption function is also referred to Propensity to consume which means willingness to spend i.e. given the
amount of income , how much the person is willing to spend on consumption expenditure.
 Consumption function/ Propensity to consume is of further to types:
 1.Average Propensity to consume(APC)
 2.Marginal Propensity to consume(MPC)
Determinants of Propensity to Consume:
 SUBJECTIVE FACTORS:  OBJECTIVE FACTORS:

 Foresightedness  change in money income
 Economic independence  Change in real wage
 Occupational motive  Distribution of income
 Miserliness  Windfall gain or losses
 Status in the society  Change in expectation
 Precautionary motives  Change in rate of interest
 Extension of business  Availability of goods
 Liquidity Preference  Change in population
 Financial Prudence  Development of means of transport
CHARACTERISTICS OF PROPENSITY TO CONSUME
 Its a psychological concept.
 Unequal propensity to consume
 Income and Employment depend on propensity to consume.
 Consumption in short run,
C = C0 + bY
Where, C0 = Autonomous consumption ; b = Marginal propensity to consume ; Y = income
In the short period, consumption increases les than increase in income.
 Long run consumption function,
C = bY
In the long run, there is no autonomous consumption, rather consumption entirely depend upon marginal
propensity to consume.
TYPES OF PROPENSITY TO CONSUME:
1.Average Propensity to consume(APC)

 It refers to the proportion of total income spend on consumption expenditure.
Mathematically,
 APC = C/Y
 EXAMPLE: At income level of Rs. 1000 , the consumption is Rs. 800
 so, APC= 800/1000 = 0.8
 If income is increased by Rs. 200 and consumption by Rs.100, find APC?
 Total income = Rs.(1000+200) = Rs.1200 &
 Total consumption expenditure, C = Rs.(800+100) = 900
 APC = 900/1200 = 0.75
2.Marginal Propensity to consume(MPC)
 It refers to the ratio of change in consumption to change in income. In other words, what
proportion of increased income would be spent for consumption. Mathematically,
 MPC = C/ Y
 Where, C = Change in consumption & Y = Change in income
 For example, If income is increased by Rs. 200 and consumption by Rs.100, find MPC?
 C = Rs. 100 & Y = Rs. 200
 MPC = 100/200 = 0.5
CHARACTERISTICS OF MPC
 It is always positive . It means that consumption expenditure will always increase with
increase in income.
 Generally, it is greater than zero and less than one. It is because when income increases only
part of increased income is spent on consumption . The entire income is not spend on
consumption.so,
 MPC > 0 & MPC < 1
 MPC is constant in long run.
 Falling MPC in short period.
Causes of the fall in MPC with the increase in income:-
 Fulfilment of basic and important wants
 Constant habits in the short run
 Consumption Expenditure and level of income in the past.
 Uncertainty of future
PSYCHOLOGICAL LAW OF CONSUMPTION
 According to this law, when income increases consumption also
increases but increase in consumption is less than increase in
income
 Assumptions: Income Consumption Saving
 1. no change in psychological and institutional complex. 0 50 -50
 2. normal conditions prevail. 50 75 -25
 Laissez - faire 100 100 0
150 125 25
200 150 50
250 175 75
300 200 100
350 225 125
PSYCHOLOGICAL LAW OF CONSUMPTION
 In the diagram, income is measured horizontally and consumption is
measured vertically. 45° is the unity line where at all levels income and
consumption are equal. The С curve is a linear consumption function based
on the assumption that consumption changes by the same amount
 Its upward slope to the right indicates that consumption is an increasing
function of income. В is the break-even point where C=Y or When income
rises to 0Y2 consumption also increases to 0C2, but the increase in
G consumption is less than the increase in income, C1C2< Y1Y2 The portion of
income not consumed is saved as shown by the vertical distance between
c2 45° line and С curve, i.e., SS’.
H
C1
y2
• PROPOSITION OF THE LAW:
1) Increased aggregate income leads to increased aggregate demand but by

somewhat smaller amount.
2) Increased income is divided between consumption and savings.
3) An increase in income is unlikely to lead to either less

consumption or less savings than before.
Implications of this Law or Importance of
Propensity to consume
 Strategic importance to investment
 Possibility of General over-production & Unemployment
 Refutation of Say’s Law
 Decline in MEC (Marginal efficiency of Capital)
 Under-employment Equilibrium
 Over-saving gap
 Peaks and Truffes of Trade Cycles
 Secular Stagnation
 State intervention
 Unique process of income generation
 Inducement to invest
Measures to raise the Propensity to Consume
 Redistribution of Income
 Social Security
 Credit Facilities
 Wage Policy
 Increase in Population
 Demonstration Effect
 Urbanisation and Colonisation
 Advertisement
 Means of transport

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CONSUMPTION FUNCTION

 SUBJECTIVE FACTORS:  OBJECTIVE FACTORS:

1.Average Propensity to consume(APC)

1) Increased aggregate income leads to increased aggregate demand but by

2) Increased income is divided between consumption and savings.

3) An increase in income is unlikely to lead to either less

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