Consumption function

Graphical representation of the consumption function, where a is autonomous consumption (affected by interest rates, consumer expectations, etc.), b is the marginal propensity to consume and Yd is disposable income.

In economics, the consumption function describes a relationship between consumption and disposable income.^[1]^[2] The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a government spending multiplier.^[3]

Details[]

Its simplest form is the linear consumption function used frequently in simple Keynesian models:^[4]

C=a+b\cdot Y_{d}

where $a$ is the autonomous consumption that is independent of disposable income; in other words, consumption when income is zero. The term $b\cdot Y_{d}$ is the induced consumption that is influenced by the economy's income level $Y_{d}$ . The parameter $b$ is known as the marginal propensity to consume, i.e. the increase in consumption due to an incremental increase in disposable income, since $\partial C/\partial Y_{d}=b$ . Geometrically, $b$ is the slope of the consumption function. One of the key assumptions of Keynesian economics is that this parameter is positive but smaller than one, i.e. $b\in (0,1)$ .^[5]

Keynes also took note of the tendency for the marginal propensity to consume to decrease as income increases, i.e. $\partial ^{2}C/\partial Y_{d}^{2}<0$ .^[6] If this assumption is to be used, it would result in a nonlinear consumption function with a diminishing slope. Further theories on the shape of the consumption function include James Duesenberry's (1949) relative consumption expenditure,^[7] Franco Modigliani and Richard Brumberg's (1954) life-cycle hypothesis, and Milton Friedman's (1957) permanent income hypothesis.^[8]

Some new theoretical works following Duesenberry's and based in behavioral economics suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviorally-based aggregate consumption function.^[9]

Notes[]

^ Algebraically, this means $C=f(Y_{d})$ where $f\colon \mathbb {R} ^{+}\to \mathbb {R} ^{+}$ is a function that maps levels of disposable income $Y_{d}$ —income after government intervention, such as taxes or transfer payments—into levels of consumption $C$ .
^ Lindauer, John (1976). Macroeconomics (Third ed.). New York: John Wiley & Sons. pp. 40–43. ISBN 0-471-53572-9.
^ Hall, Robert E.; Taylor, John B. (1986). "Consumption and Income". Macroeconomics: Theory, Performance, and Policy. New York: W. W. Norton. pp. 63–67. ISBN 0-393-95398-X.
^ Colander, David (1986). Macroeconomics: Theory and Policy. Glenview: Scott, Foresman and Co. pp. 94–97. ISBN 0-673-16648-1.
^ Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich. p. 96. The fundamental psychological law ... is that men [and women] are disposed, as a rule and on average, to increase their consumption as their income increases, but not as much as the increase in their income.
^ Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich. The marginal propensity to consume is not constant for all levels of employment, and it is probable that there will be, as a rule, a tendency for it to diminish as employment increases; when real income increases, that is to say, the community will wish to consume a gradually diminishing proportion of it.
^ Duesenberry, J. S. (1949). Income, Saving and the Theory of Consumer Behavior.
^ Friedman, M. (1957). A Theory of the Consumption Function.
^ d’Orlando, F.; Sanfilippo, E. (2010). "Behavioral foundations for the Keynesian consumption function" (PDF). Journal of Economic Psychology. 31 (6): 1035. doi:10.1016/j.joep.2010.09.004.

External links[]

An essay examining the strengths and weaknesses of Keynes's theory of consumption

[1] Algebraically, this means $C=f(Y_{d})$ where $f\colon \mathbb {R} ^{+}\to \mathbb {R} ^{+}$ is a function that maps levels of disposable income $Y_{d}$ —income after government intervention, such as taxes or transfer payments—into levels of consumption $C$ .

[2] Lindauer, John (1976). Macroeconomics (Third ed.). New York: John Wiley & Sons. pp. 40–43. ISBN 0-471-53572-9.

[3] Hall, Robert E.; Taylor, John B. (1986). "Consumption and Income". Macroeconomics: Theory, Performance, and Policy. New York: W. W. Norton. pp. 63–67. ISBN 0-393-95398-X.

[4] Colander, David (1986). Macroeconomics: Theory and Policy. Glenview: Scott, Foresman and Co. pp. 94–97. ISBN 0-673-16648-1.

[5] Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich. p. 96. The fundamental psychological law ... is that men [and women] are disposed, as a rule and on average, to increase their consumption as their income increases, but not as much as the increase in their income.

[6] Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich. The marginal propensity to consume is not constant for all levels of employment, and it is probable that there will be, as a rule, a tendency for it to diminish as employment increases; when real income increases, that is to say, the community will wish to consume a gradually diminishing proportion of it.

[7] Duesenberry, J. S. (1949). Income, Saving and the Theory of Consumer Behavior.

[8] Friedman, M. (1957). A Theory of the Consumption Function.

[9] ’Orlando, F.; Sanfilippo, E. (2010). "Behavioral foundations for the Keynesian consumption function" (PDF). Journal of Economic Psychology. 31 (6): 1035. doi:10.1016/j.joep.2010.09.004.

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show v t Consumption
Topics	Consumption function Final consumption expenditure Instant gratification Intertemporal consumption Random walk hypothesis Autonomous consumption Induced consumption Conspicuous consumption
Theories	Absolute income hypothesis Life-cycle hypothesis Permanent income hypothesis Random walk model of consumption Relative income hypothesis
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Consumption function

Contents

Details[]

See also[]

Notes[]

Further reading[]

External links[]