Consumption is ‘be all’ and ‘end all’
Income is the most important determinant.
Psychological Law of Consumption.
Three relatively common consumption
• Constant MPC and declining APC
“Men are disposed, as a rule and on an
average to increase their consumption as
their income increases, but not as much
as the increase in their income”
• Keynes did not provide statistical
• Consumption function puzzle (Keynes
• Three important hypotheis.
a. Relative Income Hypothesis-James
Dussenbery. He recognised the social
character of the consumption. Relative
income and not absolute. Demonstration
• The permanent income hypothesis-Milton
Friedman. Future as well as current incomefuture income consists of two streams-empirical
measure is required-Transitory consumption and
• Life Cycle Hypothesis-Modigliani and AndoPlanning consumption and saving over a long
period of time-allocation of consumption in the
best possible manner-Maximising his utility over
entire life span-savings-dissavings.
• People do not want to consume over their
lifetimes at precisely the same time and
amounts they earn income. Thus they
save and dissave so as to consume their
life time incomes in the pattern they want.
They save while working, and then use the
savings to finance in their retirement
Importance of Consumption
1. The concept helps to invalidate Say’s law
2. Significance of investment demand
3. It helps to derive the theory of multiplier
• Investment Multiplier
• Algebraic derivation of multiplier
• Assumptions : Instant change, excess
capacity in consumer goods industries,
closed economy, increase in money as
well as real terms.
Importance: Helps in understanding the
business cycles, importance of fiscal
• Automatic adjustment between production
• Full employment
• Equality of saving and investment.
• Economy would continue to employ the
• Demand and supply of labour
• Demand depends on output and also
• MPP is subject to law of diminishing
• Employers would continue to employ till
• Aggregate Demand: Is the total sum of
money or proceeds, which is expected
from the sale of the output produced when
that amount of labour is employed.
• Aggregate Supply: Is a schedule of the
minimum amounts of proceeds required to
induce varying quantities of employment.
It is not high prices
No absolute price rise
Input Output relationship
No pre-determined set of causes and effects
Greater need for means of payment
Expectations of further rise
Holding back supplies
Change in asset preference
Increase in Interest rates initially
Growing inequalities in income
• Demand Pull
• Cost Push
a) Wage Push b) Profit Push
They are often interwined
• Keynes Model: National Income and
Output is determined by investment which
in turn is determined by the rate of interest
which in turn is determined by the demand
and supply of money.
• Only one way relationship was found to be
• J.R. Hicks developed the IS-LM model.
• The IS curve is a graphic representation of
the product market equilibrium condition
that planned investment be equal to
saving and it shows the level of income
that will yield equality of planned
investment and saving at different possible
• The LM Curve is a graphic representation
of the monetary equilibrium condition, and
it specifies the level of income which, for
different rates of interest, makes the
demand for money equal to the supply of