Psychological Law of Consumption By J.M Keynes:
J.M. Keynes, in his book
‘General Theory’ analyzed the consumption behavior of the
community on the basis of human psychology. He propounded a law
which is known as Psychological Law of Consumption.
Statement:
According to this law:
"The household sector spends a major
part of its income on the purchase of consumer goods and
services such as food, clothing, medicines, shelter etc., for
personal satisfaction. The expenditure on consumption (C) is the
largest component of aggregate expenditure. Whatever is not
consumed out of disposable income is by definition called saving
(S)".
Formula:
Disposable Income =
Consumption + Saving
I = C + S
Explanation:
According to Keynes, the level of
consumption in a community depends upon the level of disposable
income. As income increases, consumption also increases but it
increases not as fast as income i.e., it increases at a
diminishing rate. This relationship between consumption and
disposable income is called consumption function.
In the words of Keynes:
“Men are disposable as a rule and on
the average to increases their consumption as their income
increases, but hot by as much as the increases in their income.”
Properties of Consumption Behavior
of Community:
The psychological law of consumption
brings out the following properties of the consumption behavior
of the community:
(i) The level of consumption is
directly functionally related to the level of disposable income
= C = f(y)
(ii) With the rise in the level of
income, the consumption level also rises, but at a decreasing
rate = ΔC < Δy
(iii) As the level of income
increases, the households devote a part of the increase saving.
Symbolically: ΔY = ΔC + ΔS
The Keynesian consumption
function is now explained with the help of schedule and
a curve.
Schedule:
($ in billion)
|
Disposable Income (Y) |
Consumption (C) |
Saving (S) |
APC (C/Y) |
MPC (ΔC/ΔY) |
| 0 |
50 |
-50 |
|
|
|
100 |
100 |
0 |
1.00 |
0.5 |
|
200 |
150 |
50 |
0.75 |
0.5 |
|
300 |
200 |
100 |
0.67 |
0.5 |
In the schedule, it is shown that as
the nation’s disposable income increases, the aggregate
consumption at various levels of income also increases but at a
decreasing rate.
The same data is now shown in graph
30.1 below:
Diagram/Graph:
Following are the observations
about the functional relationship between the national
disposable income and the economy’s aggregate expenditure.
(i) At every point on the 450
line OY, a vertical line drawn to the income axis is at the same
distance from the origin as a horizontal line drawn to the
consumption axis. The 450 line thus is the line along
which expenditure equals real income.
(ii) The consumption function is
represented by consumption line (C). The consumption line C is
positively sloped indicating that as the disposable income
increases, the expenditure in the economy also increases.
(iii) The consumption line (C)
intercepts at Y axis showing negative saving of $50 billion
during a short period.
(iv) At point B the consumption line
(C) intersects the 450 helping line (OY) saving. At
point B, consumption equals disposable income and there is zero
saving. B is called the break even point.
(v) Left to the point B, the
consumption line C is above the income line Y. It indicates
negative saving.
(vi) Right to the point B, the
consumption line C is below the income line Y. It denotes
positive savings.
Summing up, the relationship
between consumption and disposable income is referred to
as consumption function. A consumption function tells
how much households plan to consume at various levels of
disposable income.
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