The consumption function, introduced by John Maynard Keynes, defines the relationship between total consumption and gross national income, predicting aggregate consumption expenditures. It is influenced by subjective factors, such as psychological motivations, and objective factors, including fiscal policy and market conditions. Understanding the consumption function is critical for economists and policymakers to make informed decisions regarding monetary and fiscal policies.

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Unit – III: Consumption Function
Factors affecting consumption - Keynes Psychological law of consumption - Relationship
between Average and Marginal Propensity to Consume.
CONSUMPTION FUNCTION:
The consumption function is an economic formula that represents the relationship between
total consumption and gross national income (GNI). It was first introduced by British
economist John Maynard Keynes, who argued that the function could be used to predict total
aggregate consumption expenditure.
The consumption function is a valuable tool for understanding the economic cycle and
guiding economists and policymakers as they make key decisions about investments, as well
as monetary and fiscal policy.
Understanding the Consumption Function
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. Put simply, it can be used to estimate and predict spending in the future.
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 the 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.
Based in part on Keynes' psychological law of consumption theory, the stability of the
consumption function is a cornerstone of Keynesian macroeconomic theory. This is
especially true when it is contrasted with the volatility of an investment, Most post-
Keynesians admit the consumption function is not stable in the long run
since consumption patterns change as income rises.
Calculating the Consumption Function:

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The consumption function is represented as:
C = A + MD
where:
C=consumer spending
A=autonomous consumption (It is the minimum amount of money spent on necessities,
regardless of income level)
M=marginal propensity to consume (the proportion of total income or of an increase in
income that consumers tend to spend on goods and services rather than to save)
D=real disposable income (It is a measure of how much money a household or individual has
to spend after taxes)
Why Is the Consumption Function Important?
There are multiple reasons why the consumption function is important to economics. It is a
macroeconomic tool that can help economists understand the economy, including how
business cycles work and the function of the money supply among others. Economists and
decision-makers can use it (and the formula) to make investment decisions and shape
monetary and fiscal policy to direct the economy.
FACTORS AFFECTING CONSUMPTION FUNCTIONS:
Factors Affecting Consumption Functions: Subjective and Objective Factor!
According to Keynes, two types of factors influence the consumption function: subjective
and objective. The subjective factors are endogenous or internal to the economic system
itself. The subjective factors relate to psychological characteristics of human nature, social
structure, social institutions and social practices.
The objective factors affecting the consumption function are exogenous, or external to the
economy itself. These factors may at times undergo rapid changes. Thus, objective factors
may cause a shift in the consumption function.

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Subjective Factors:
Subjective factors basically underlie and determine the form of the consumption function
(i.e., its slope and position).
The subjective factors concerned are:
(1) behaviour patterns fixed by the psychology of human nature
(2) the institutional arrangements of the modern social order, and social practices relating to
the behaviour patterns of business firms with respect to wage and dividend payments and
retained earnings, and the institution controlling the distribution of income.
Human behaviour regarding consumption and savings out of increased income depends on
psychological motives.
First, there are motives which “lead individuals to refrain from spending out of their
incomes.”
Keynes enlists eight such motives:
1. The Motive of Precaution:
The desire to build up a reserve against unforeseen contingencies.
2. The Motive of Foresight:
The desire to provide for anticipated future needs, e.g., in relation to old age, family
education, etc.
3. The Motive of Calculation:
The desire to enjoy interest and appreciation, because a larger real consumption, at a later
date, is preferred to a smaller immediate consumption.
4. The Motive of Improvement:
The desire to enjoy a gradually increasing expenditure since it gratifies the common instinct
to look forward to a gradually improving standard of life rather than otherwise.
5. The Motive of Independence:
The desire to enjoy a sense of independence and the power to do things.

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6. The Motive of Enterprise:
The desire to secure a mass de manoeuvre to carry on speculation or establish business
projects.
7. The Motive of Pride:
The desire to possess or to bequeath a fortune.
8. The Motive of Accumulation:
Keynes listed the following motives for accumulation:
(a) The Motive of Enterprise:
The desire to do big things, to expand, to secure resources to carry out further capital
investment.
(b) The Motive of Liquidity:
The desire to face emergencies and difficulties successfully.
(c) The Motive of Improvement:
The desire to secure a rising income and to demonstrate successful management.
(d) The Motive of Financial Prudence:
The desire to ensure adequate financial provision against depreciation and
obsolescence and to discharge debts.
Objective Factors:
Objective factors, subject to rapid changes and causing violent shifts in the consumption
function, are considered below:
1. Windfall Gains or Losses:
When windfall gains or losses accrue to people their consumption level may change
suddenly. For instance, the post-war windfall gains in stock exchanges seem to have raised
the consumption spending of rich people in the U.S.A., and to that extent, the consumption
function was shifted upward.
2. Fiscal Policy:
The propensity to consume is also affected by variations in fiscal policy of the government.
For instance, imposition of heavy taxes tends to reduce the disposable real income of the

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community; so its level of consumption may adversely change. Similarly, withdrawal of
certain taxes may cause an upward shift of consumption function.
3. Change in Expectations:
The propensity to consume is also affected by expectations regarding future changes. For
instance, an expected war considerably influences consumption by creating fears about future
scarcity and rising prices. This leads people to buy more than they immediately need, i.e., to
hoard. Thus, the ratio of consumption to current income will rise, which means that the
consumption function will be shifted upward.
4. The Rate of Interest:
In the long run, substantial changes in the market rate of interest may also influence
consumption. A significant rise in the rate of interest may induce people to reduce their
consumption at each income level, because people will save more in order to take advantage
of the high interest rate.
KEYNES PSYCHOLOGICAL LAW OF CONSUMPTION:
The functional relationship between consumption and national income is known as
Consumption Function. It was introduced by John Maynard Keynes and represents the
willingness of households to purchase goods and services at a given income level during a
given period of time. It is represented as C = f(Y); where C = Consumption, Y = National
Income and f = Functional Relationship. The consumption function is a psychological
concept that shows consumption levels at different income levels in an economy. Besides, it
is influenced by subjective factors like consumer habits, preferences, etc.
Consumption Function is based on the Psychological Law of Consumption introduced by
Keynes. The Psychological Law of Consumption states three main things:
 Even at zero income level, there is minimum consumption, i.e., autonomous
consumption which is required for the survival needs of people.
 Consumption increases with the increase in income.
 The rate at which income increases is more than the rate of increase in consumption.

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Let’s understand the concept of Consumption Function with the help of the following
consumption schedule and consumption curve.
In the above graph, X-axis represents National Income, and Y-axis represents Consumption
Expenditure.
Observation:

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1. Starting Point: The consumption curve (CC) starts from point C and not from point O,
which means that even at a zero level of national income, there is autonomous consumption (
C) of OC.
2. Slope of Consumption Curve: The slope of the consumption curve CC is positive, which
means that with an increase in income, consumption also increases. However, the rate at
which consumption increases is less than the rate of increase in income because the consumer
saves a part of his income and spends the rest.
3. Income is less than Consumption: As seen in the above table and graph, income is less
than consumption at income levels less than ₹200 Crores and OM, respectively. This gap
between consumption and income level is covered by dis-savings. Dis-savings is the
previous savings of the consumer. In the above graph, dis-savings is the shaded
area .
4. Break-even Point; i.e., C = Y: Break-even point is the point at which consumption is
equal to income. In the above graph, the break-even point is achieved at point E with OM
income level; i.e., at the income of ₹200 Crores. Also, at the break-even point, savings is
zero.
5. Income is more than Consumption: As seen in the above table and graph, income is
more than consumption at income levels more than ₹200 Crores and the points to the right of
Point E, respectively. This excess income results in savings. It means that the gap after point
E between the 45° line and the CC line represents positive savings.
Note: The 45° line is drawn to indicate whether the consumption is less than, equal to, or
more than the income level.
Types of Propensities to Consume
The two types of Propensities to Consume are Average Propensity to Consume (APC) and
Marginal Propensity to Consume (MPC).
1. Average Propensity to Consume (APC):
It is the ratio of consumption expenditure to the corresponding income level. The formula to
determine Average Propensity to Consume (APC) is:
Average Propensity to Consume (APC) = Consumption (C) / Income (Y)

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APC can be equal to one, less than one, and more than one, but can never be zero. According
to the formula, APC can be zero when the consumption level is zero, which is not possible at
any income level because even at zero income level, there is autonomous consumption (C).
2. Marginal Propensity to Consume (MPC):
It is the ratio of the change in consumption expenditure to the change in total income. In
simple terms, MPC explains the proportion of change income that is spent on consumption.
The formula to determine Marginal Propensity to Consume (MPC) is as follows:
Marginal Propensity to Consume (MPC) = Change in Consumption ( C) / Change in Income
( Y)
The value of MPC varies between 0 and 1. Besides, the Marginal Propensity to Consume
(MPC) of the poor is more than the MPC of the rich. It is because the poor spend most of
their increased income on consumption as most of their basic needs are not yet fulfilled.
However, rich people spend less of their increased income on consumption as they are
already enjoying a high living standard.
Relationship between Average and Marginal Propensity to Consume:
The relationship between APC and MPC is crucial to understanding household consumption
behavior. While APC indicates the average proportion of disposable income spent by
households, MPC measures the change in spending for a given change in disposable income.
APC (Average Propensity to Consume) MPC (Marginal Propensity to Consume)
Calculated as a ratio of consumption to
disposable income. It shows the
proportion of disposable income that is
spent on consumption.
Calculated as a change in consumption to change
in disposable income. It shows how much
consumption changes with a change in disposable
income.
A measure of overall consumption habits.
It gives an idea of how much disposable
income people are spending on
consumption on average.
A measure of how sensitive consumption is to
changes in disposable income. It gives an idea of
how much consumption changes when disposable
income changes.
A static measure, does not change with A dynamic measure, changes with changes in

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changes in disposable income. It is a
constant value for a given level of
income.
disposable income. It is not a constant value for a
given level of income. It changes as income
changes.
Represented by a straight line on a graph.
The slope of the line represents the APC.
Represented by a curve on a graph. The slope of
the curve at a given point represents the MPC at
that point.
It is used to measure how much money is
being spent on consumption on average,
which can be used to predict consumption
patterns.
It is used to measure how changes in disposable
income affect consumption, which can be used to
predict the effects of changes in government
policies or economic conditions.
It is a widely used measure in economics,
and is used in various macroeconomic
models to make predictions about
consumption patterns.
It is also widely used in economics, and is used in
various macroeconomic models to make
predictions about the effects of changes in
government policies or economic conditions.
Key differences between APC and MPC
1. APC (Average Propensity to Consume) is calculated by dividing total consumption
expenditure by total disposable income.
2. MPC (Marginal Propensity to Consume) is calculated by dividing the change in
consumption expenditure by the change in disposable income.
3. APC is a measure of the proportion of disposable income that is typically spent by
households, while MPC is a measure of the responsiveness of consumption to changes
in disposable income.
4. APC is a static measure, while MPC is a dynamic measure.
5. APC is always less than or equal to 1, as total consumption expenditure cannot exceed
total disposable income.
6. MPC can be greater than 1, if the change in consumption expenditure is greater than
the change in disposable income.
7. APC is useful for understanding the overall consumption behavior of households,
while MPC is useful for understanding how changes in disposable income affect
consumption.

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