Learn about the key characteristics of the Keynesian consumption function and how it impacts economic theory and policy.
What determines the aggregate amount of goods purchased by consumers in any time period? In the elementary Keynesian model, the real income of households basically provides the answer. A rise in real income will lead households to increase the amount of goods purchased and vice versa. This does not deny that there are many other less important determinants of real consumer spending. Here the assumption is that the aggregate amount of consumer goods purchased or the aggregate amount of real consumer spending is determined exclusively by the real income of consumers, that is, by real disposable personal income.
To consider how consumption expenditures are related to disposable income, we may begin by positing that consumption expenditures vary directly with disposable income. Second, we can be more specific and say something about how much such expenditures will vary as disposable income varies. Keynes did this in his “fundamental psychological law” which states that “men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.”
In other words, as income increases, consumer will spend part but not all of the increase, choosing instead to save some pari of it. Therefore, the total increase in income will be accounted for by the sum of the increase in consumption expenditures, and the increase in personal saving.
Characteristics of Keynesian Consumption Function In Economics.
Consumption expenditure depends on the amount of income
Keynes stated that consumption expenditure depends on the amount of income. Where consumption tends to be smaller than income.
A person can make additional consumption ( marginal propensity to consume ) in large amounts if his income is also large. Keynesian economic theory is different from classical economists who only study the case of full employment.
This is because Keynes’ theory applies to the entire economic system, both individual economies (full-time workers, part-time workers, and unemployed), industries, companies, and governments. This is why Keynes’ theory is called the General Theory because it applies generally in economics.
Keynes also stated that there is consumption that must still be met, such as basic needs. This need is called autonomous consumption, which must still be met even though the income owned is equal to zero.
Consumption expenditure has nothing to do with income
Keynes stated that consumption expenditure does not have a proportional relationship with income. Keynes believed in the principle of effective demand.
Marilyn Cohn in the journal The Economics of John Maynard Keynes (1949) stated that the basis of the principle of effective demand is that if real income increases, consumption will also increase but less than the increase in income.
This is because when income increases, a person can fulfill his/her autonomous needs. So that he/she can do additional consumption ( marginal propensity to consume ) outside of basic needs.
Milton Friedman in his book A Theory of the Consumption Function (1957) said that Keynes believed in the basic psychological rule of modern society that when real income increases, consumption will not increase by the same absolute amount as the increase in savings.
When income increases, the amount of income saved will also increase or be greater than before. So the average propensity to consume will decrease. People with higher incomes tend to save large amounts because they take into account the amount of interest they will get
Marginal propensity to consume
According to Keynes, the amount consumed from each additional dollar (money) is between zero (0) and one (1).This assumption explains that the higher a person’s income, the higher their level of consumption and savings.
Consumption to income ratio
This assumption of Keynesian consumption theory is often also called the average propensity to consume.When a person’s income increases, it turns out that their consumption level does not always increase.
In this assumption, Keynes explains that even if a person’s income increases, their consumption level may decrease.Furthermore, he explained that the proportion of savings of rich people is greater than that of less fortunate people.When sorted, you will usually see an increasing proportion of savings to income.
Income is a determinant of consumption
In this assumption, Keynes wants to emphasize that income is an important determinant of consumption. While the interest rate, its role is not very important.
The assumption of Keynesian consumption theory is contrary to classical economics, which assumes that the higher the interest rate, the savings rate will increase and consumption will decrease.
In everyday life, the function of savings and consumption are two things that are inseparable from economic activities . Where, every society will definitely allocate their income for savings and consumption purposes.