macroeconomics

1. LAW OF CONSUMPTION
OF KEYNES
BY: Amrina abid

2. DEFINITION
• Consumption: the household purchases of all final goods and services is called the
consumption.
• Consumption function: the relationship between level of income in an economy and
the amount the households plants to spend on consumption, other things constant.
• It is a Keynesian relationship between income and consumption.
• A relationship showing the determinants the consumption. For example: a
relationship between consumption and disposable income.
C=C(Y-T)
General Keynesian consumption function: C=f(Y)
Standard form: C=C0+CY

3. INTRODUCTION
• Keynes presented this law in 1936 in his book “ general theory”. This law states that:
“ the average tendency on the part of the people is this whenever
the incomes increases they increase the consumption but not as
much as their income increases.”

4. ASSUMPTIONS:
• It is a short run model. There is non proportional relationship between income and
consumption.
• There are no changes in the tastes, habits, fashion and distribution of income.
• This law assumes that there is the free market economy and people are free to make
their choices regarding consumption and savings.
• There prevail normal conditions in the economy. It means there is neither
hyperinflation nor droughts, nor wars.

5. FEATURES
• According to this law as income increase, then consumption will also increase but at
decreasing rate.
• The second important feature of this law is that there exist non proportional
between consumption and income.
• People with higher income(Y) will have higher savings and people with lower
income will have lower savings.
• When consumption does not increase in the same proportion to income the savings
will rise. ∆y=∆c+∆s

6. IMPLICATIONS
• Negative of say’s law: according to say’s law “supply creates its own demand” and
“AD remains equal to AS and nothing remains unsold” but according to Keynes “
people do not spend all of the increase in the income as a result there is a chance of
unsold goods over production and consumption.
• Crucial importance of aggregate demand: people do not divert (spend) all of
increases in their income to purchase the goods which have been produced by
them. In this way the economy may face the phenomenon of the over production
and unemployment.
• Income propagation: Keynes has presented the concept of investment multiplier
which states that any change in investment given the value of MPC will lead to
increase NI many a time.

7. CONCLUSION
• In short, consumption and saving depends upon the income of a person. When
income increases consumption and saving also increase but not at the same ratio, at
which ratio the income is increasing. When consumption increases it does not
change the habits distribution of income a person earn. In fact, people are free to
make their choices regarding consumption and savings.