What Is the Consumption Function?
The consumption function, or Keynesian consumption function, is an economic formula that representsthe functional relationship between total consumption and gross national income. It was introduced by British economist John Maynard Keynes, who argued the function could be used to track and predict total aggregate consumption expenditures.
Understanding the Consumption Function
The classic consumption function suggests consumer spending is wholly determined by income and the changes in income. If true, aggregate savings should increase proportionally as gross domestic product (GDP) grows over time. The idea is to create a mathematical relationship between disposable income and consumer spending, but only on aggregate levels.
The stability of the consumption function, based in part on Keynes' Psychological Law of Consumption, especially when contrasted with the volatility of investment, is a cornerstone of Keynesian macroeconomic theory. Most post-Keynesians admit the consumption function is not stable in the long run sinceconsumption patterns change as income rises.
Calculating the Consumption Function
The consumption function is represented as:
C=A+MDwhere:C=consumerspendingA=autonomousconsumptionM=marginalpropensitytoconsume
Assumptions and Implications
Much of the Keynesian doctrine centers around the frequency with which a given population spends or saves new income. The multiplier, the consumption function, and the marginal propensity to consume are each crucial to Keynes’ focus on spending and aggregate demand.
The consumption function is assumed stable and static; all expenditures are passively determined by the level of national income. The same is not true of savings, which Keynes called “investment,” not to be confused with government spending, another concept Keynes often defined as investment.
For the model to be valid, the consumption function and independent investment must remain constant long enough for national income to reach equilibrium. At equilibrium, business expectations and consumer expectations match up. One potential problem is that the consumption function cannot handle changes in the distribution of income and wealth. When these change, so too might autonomous consumption and the marginal propensity to consume.
Other Versions
Over time, other economists have made adjustments to the Keynesian consumption function. Variables such as employment uncertainty, borrowing limits, or even life expectancy can be incorporated to modify the older, cruder function.
For example, many standard models stem from the so-called “life cycle” theory of consumer behavior as pioneered by Franco Modigliani. His model made adjustments based on how income and liquid cash balances affect an individual's marginal propensity to consume. This hypothesis stipulated that poorer individuals likely spend new income at a higher rate than wealthy individuals.
Milton Friedman offered his own simple version of the consumption function, which he called the “permanent income hypothesis.” Notably, the Friedman model distinguished between permanent and temporary income. It also extended Modigliani’s use of life expectancy to infinity.
More sophisticated functions may even substitute disposable income, which takes into account taxes, transfers, and other sources of income. Still, most empirical tests fail to match up with the consumption function’s predictions. Statistics show frequent and sometimes dramatic adjustments in the consumption function.
FAQs
As noted above, the consumption function is an economic formula introduced by John Maynard Keynes, who tracked the connection between income and spending. Also called the Keynesian consumption function, it tracks the proportion of income used to purchase goods and services.
What best describes the consumption function? ›
The consumption function is an equation describing how a household's level of consumption varies with its disposable income. In order to fully understand the consumption function, we need to understand a few ideas about household income and how they choose to use that income.
What is the meaning of consumption in economics? ›
consumption, in economics, the use of goods and services by households. Consumption is distinct from consumption expenditure, which is the purchase of goods and services for use by households.
What is consumption function in GDP? ›
consumption function, in economics, the relationship between consumer spending and the various factors determining it. At the household or family level, these factors may include income, wealth, expectations about the level and riskiness of future income or wealth, interest rates, age, education, and family size.
What is an example of a consumption function? ›
- Given, the consumption function, C = 150 + 0.6Y, where C = consumption expenditure, Y = income and investment expenditure = Rs 2,000. ...
- C = 50 + 0.5 Y is the consumption function where C is consumption expenditure and Y is National Income and investment expenditure is 2,000 in an economy.
Consumption can be defined in different ways, but it is best described as the final purchase of goods and services by individuals. The purchase of a new pair of shoes, a hamburger at the fast food restaurant or services, like getting your house cleaned, are all examples of consumption.
What is the simplest consumption function? ›
The simplest consumption function assumes Consumption changes at a constant rate as income changes. Explanation: The most basic consumption function assumes that consumption changes constantly in response to changes in income.
What is the consumption function quizlet? ›
consumption function. expresses household consumption spending as a function of disposable income. consumption function formula. Y = C (consumption) + S (savings) + T (taxes) disposable income formula.
What are two characteristics of consumption function? ›
Real income: Increase in real income means an increase in purchasing power, which will lead to a rise in consumption and vice versa. 2. Taxes: Taxes affect the disposable income of the people. Increase in tax leads to a decrease in consumption and vice versa.
Why is the consumption function important? ›
The consumption function is important to help describe how future spending will occur. For a government, this can be important when implementing policies. Policies are often aimed at increasing consumer spending, as this will increase the gross GDP of the country, bringing in more wealth for the country.
the act of using, eating, or drinking something, or the amount that is used, etc.: fuel/energy, etc. consumption Water transport costs less than road transport, cuts congestion, and reduces energy consumption.
What are the types of consumption functions? ›
A linear consumption function has an MPC which will be a constant value between 0 and 1 at all levels of income. A non-linear consumption function will have the same MPC at different levels of income.
Why is consumption important in economics? ›
4 answersConsumer spending plays a significant role in driving economic growth. Increases in consumer purchasing power are seen as desirable for long-run economic growth and consumer welfare.
What are the two factors that could cause a fall in consumption? ›
Consumption is financed primarily out of our income. Therefore real wages will be an important determinant, but consumer spending is also influenced by other factors, such as interest rates, inflation, confidence, saving rates and availability of finance.
What are the factors that affect consumption function? ›
The consumption function is a key concept in macroeconomics that shows how much households spend on goods and services at different levels of income. It is influenced by various factors, such as preferences, expectations, wealth, interest rates, taxes, and government policies.
What is Keynes theory of consumption function? ›
Keynes laid stress on the absolute size of current income as a determinant of consumption, for which his theory of consumption is also known as absolute income theory of consumption. The Keynes' consumption function can be expressed in the following form: C = a + bYd.
Why do we consume the functions of consumption? ›
Consumption is supposed to result in increased well-being by making things easier and more convenient (e.g. a car gives us greater mobility, many electrical appliances simplify certain tasks, and so on). Furthermore, we consume certain goods or services for pleasure (e.g. games, leisure cruises).
What is the difference between production function and consumption function? ›
Answer and Explanation:
The method of production is carried out to satisfy human wants. Consumption is a process in which a substance is used up. It involves the usage of a product for a period.
