# Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

## Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

Karnataka Class 12 Commerce Economics Keynes Consumption Function : The university was recognized with the “Potential for Excellence” by the University Grants Commission. The university is the second oldest university in the state of Karnataka after the University of Mysore. The Karnatak university once used to serve most of the Karnataka region including Dharwad, Belagavi, Uttara Kannada, Bijapur, Gulbarga, Raichur, Bidar and Bellary. until the 1980s (Manipal Institute of Technology and the Kasturba Medical College of Manipal were affiliated with Karnatak University at Dharwad and all degrees were awarded by Karnatak University in between the years from 1953 to 1965)

### Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

Karnataka Class 12 Commerce Economics Keynes Consumption Function : Economics is a social science concerned with the production, distribution and consumption of goods and services. It studies how individuals, businesses, governments and nations make choices on allocating resources to satisfy their wants and needs, and tries to determine how these groups should organize and coordinate efforts to achieve maximum output.

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### Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

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Karnataka Class 12 Commerce Economics Keynes Consumption Function : In economics, the consumption function describes a relationship between consumption and disposable income. The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a government spending multiplier. Its simplest form is the linear consumption function used frequently in simple Keynesian models:

{\displaystyle C=a+b\times Y_{d}}

where {\displaystyle a} is the autonomous consumption that is independent of disposable income; in other words, consumption when income is zero. The term {\displaystyle b\times Y_{d}} is the induced consumption that is influenced by the economy’s income level. The parameter {\displaystyle b} is known as the marginal propensity to consume, i.e. the increase in consumption due to an incremental increase in disposable income, since {\displaystyle \partial C/\partial Y_{d}=b}. Geometrically, {\displaystyle b} is the slope of the consumption function. One of the key assumptions of Keynesian economics is that this parameter is positive but smaller than one, i.e. {\displaystyle b\in (0,1)}.[

Keynes also took note of the tendency for the marginal propensity to consume to decrease as income increases, i.e. {\displaystyle \partial ^{2}C/\partial Y_{d}^{2}<0}. If this assumption is to be used, it would result in a nonlinear consumption function with a diminishing slope. Further theories on the shape of the consumption function include James Duesenberry’s (1949) relative consumption expenditure, Franco Modigliani and Richard Brumberg’s (1954) life-cycle hypothesis, and Milton Friedman’s (1957) permanent income hypothesis.

Some new theoretical works are based, following Duesenberry’s one, on behavioral economics and suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviorally-based aggregate consumption function.

### Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

Karnataka Class 12 Commerce Economics Keynes Consumption Function : The , THE relation between aggregate consumption or aggregate savings and aggregate income, generally termed the consumption function, has occupied a major role in economic thinking ever since Keynes made it a keystone of his theoretical structure in The General Theory. Keynes took it for granted that current consumption expenditure is a highly dependable and stable function of current income—.that “the amount of aggregate consumption mainly depends on the amount of aggregate income (both measured in terms of wage units).” He termed it a “fundamental psychological rule of any modern community that, when its real income is increased, it will not increase its consumption by an equal absolute amount,” and stated somewhat less definitely that “as a rule, . . . a greater proportion of income. . . (is) saved as real income increases.” DETERMINANTS OF CONSUMPTION EXPENDITURE According to Keynes, the amount of consumption expenditure depends on the size of national income. This functional relationship is called the propensity to consume or consumption function. Symbolically it is expressed as

C = f (Y)

Where C is consumption expenditure and Y is level of income. Algebraically Keynes consumption function is given as C = a + b Y Where, a is the Minimum Subsistence Consumption Demand b is Marginal Propensity to Consume Y is Level of Income Keynes consumption curve is shown in the following diagram.

The below mentioned article provides a close view on Keynesian consumption function.

The consumption function states that aggregate real consumption expenditure of an economy is a function of real national income. This is called the Keynesian Consumption Function. The classical economists used to argue that consumption was a function of the rate of interest such that as the rate of interest increased the consumption expenditure decreased and vice versa. Keynes stated that the rate of interest may have some influence on consumption but the real income was the important determinant of consumption.

It should be remembered that in the consumption function consumption expenditure refers to intended or ex-ante consumption and not actual consumption. Similarly, income refers to anticipated income and not actual income. Therefore, the consumption function shows what consumption expenditure would be at different levels of income. The aggregate consumption in the economy can be found out from the consumption expenditure of different individuals purchasing commodities.

This means that, when all prices and the level of income change in the same proportion, the consumption expenditure will also change in the same proportion. If we write all prices as P and all money incomes as Ym, then we can write that Cm = Cm (Ym, P) where Cm is the aggregate consumption expenditure in money terms. This function will also be homogeneous of degree one in Ym and P.

Thus, the aggregate consumption function states that real consumption is a function of real income and then the consumption function can be written as C = C(Y) where C is real consumption expenditure and Y is real national income. This is the Keynesian Consumption Function. The straight line consumption function has a constant slope at all points. The (MFC) marginal propensity to consume decreases as income increases.

According to Keynes the consumption function must possess the following characteristics:

(1) Aggregate real consumption expenditure is a stable function of real income.

(2) The marginal propensity to consume (MPC) or the slope of the consumption function defined as dc/dY must lie between zero and one i.e. 0 < MPC < 1.

(3) The average propensity to consume (APC) or the proportion of income spent on consumption defined as C/Y should be decreasing as income increases. From the relation between marginal and average we know that, when average falls, marginal is below average. Thus, when the average propensity to consume (APC) falls, the marginal propensity to consume (MPC) must be lower than the APC.

(4) The marginal propensity to consume (MPC) itself probably decreases or remains constant as income increases.

These four characteristics specify the shape of the consumption function. It can be seen clearly that, if we draw a straight line consumption function with a positive intercept with the vertical axis, and intersecting the 45° line from above, it will satisfy all the four characteristics. In Fig. 12.1 we draw Y on the horizontal axis and C on the vertical axis.

The consumption function, PQ, is a straight line and OT is a straight line passing through the origin making an angle of 45° which intersect the consumption function from below at point T. This consumption function PQ satisfies all the four characteristics.

(i) It represents a stable relationship between C and Y.

(ii) The slope of the line PQ represents the marginal propensity to consume (MPC) which has a positive slope. Again the consumption function cuts the 45° line from above. This means consumption function (PQ) is flatter than the 45° line and its slope is less than 45° line. The slope of PQ = MFC and the slope of the 45° line = tan 45° = 1. Thus, it satisfies the second characteristic that 0 < MPC < 1.

(iii) But the average propensity to consume will be different at different points of the consumption function. For example, at point P, C = OP and Y = 0, so that, APC = C/Y = OP/O = ∞.

It means at point P, the APC is infinity (∞). Again consider the point T where consumption is TS and income is OS, so that, APC = TS/OS = slope of OT = 1. Thus, APC at point T is one. The APC at any point on the consumption function is slope of the line joining that point with the origin. To the left of T, the AFC is greater than one and to the right of T, AFC is less than one. It means, to the left of the point T consumption is greater than income i.e., C > Y, so that, APC = C/Y > 1.

On the other hand, to the right of the point T, consumption is less than income, i.e. C < Y, so that, APC = C/Y < 1. Thus, the APC decreases as we move along the consumption function from left to right. Since the average propensity to consume (APC) decreases as income increases the marginal propensity to consume (MPC) must be less than the average propensity to consume. Thus, the third characteristic is also fulfilled by this straight line consumption function.

Fourthly, if the consumption function is a straight line the slope of the consumption function is constant at all points, i.e. the constant MFC satisfies the fourth characteristic. If the MFC is to decrease as income increases the consumption function has to be non-linear. It will be concave to the horizontal axis. In other words, the equation of a straight line linear consumption function can be written as C = a + bY, where a and b are constants. Let us also assume that a > 0 and 0 < b < 1 and dc/dY = b = MPC. Since b > 0, the function is upward rising. Again the APC = C/Y = a/Y + b. In this case, C/Y will decrease as Y increases. So the APC = C/Y = a/Y + dc/dY = MPC + x. ... APC > MPC.

These four characteristics of the consumption function mentioned by Keynes were not derived from theoretical analysis or empirical evidence. He derived these proportions from intuition. Keynes called it a “fundamental psychological law” that people do not spend the entire amount of the increase in income and save a part of it. This means that, marginal propensity to consume (MPC) is positive but less than one. The consumption income ratio falls as income increases which means that there is a non-proportional relationship between consumption and income.

#### Subjective and Objective Factors Affecting Consumption Expenditure:

According to Keynes, aggregate real consumption expenditure depends on aggregate real national income, other things remaining constant.

The factors other than the level of income that affect consumption can be divided into three groups:

(a) Subjective,

(b) Objective and

(c) Structural.

Subjective factors are psychological ones that cannot be quantitatively measured. Objective factors are considered to be economic variables that can be measured quantitatively. Structural factors include aspects particularly relevant for the problem of aggregation. Let us first consider the subjective or psychological factors affecting consumption.

The subjective factors consist of basic values, states of mind, attitudes, etc., which cannot be measured in quantitative terms. Keynes discuss the various motives for saving, such as, precaution, foresight, enterprise, pride and avarice; and also the motives-for consumption, such as, “enjoyment, short-sightedness, generosity, miscalculation, ostentation and extravagance.” He called them subjective factors that are unlikely to change significantly in the short-run.

Psychological factors, such as, expectations and attitudes do influence consumption. Rational behaviour suggests that a consumer who expects an increase in income or in price level would consume more than one who expects no such changes. Keynes accepted this logic but felt that expectations can be ignored because different people in an economy will have different expectations, and such expectations will probably cancel out each other in the aggregate analysis.

Now, let us consider the objective factors. The first objective factor after income is the interest rate. A rise in the interest rate may affect aggregate consumption expenditure in various ways. For example, a rise in the rate of interest will reduce bond prices, thereby discouraging the consumption propensities of the bondholders.

### Karnataka Class 12 Commerce Economics Keynes Consumption Function Complete Notes

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