Determinants of Propensity to Consume

1) Consumption function
The consumption function shows the relationship between income and consumption, i.e., how much people plan to spend on consumption at different levels of income.​​

2) Propensity to consume
Propensity to consume means the tendency of people to spend a part of their income on consumption rather than saving it.​​

• Higher propensity to consume → people spend a larger part of their income.
• Lower propensity to consume → people save more and spend a smaller part.

Keynes said that consumption depends mainly on income but is also influenced by many subjective (psychological) and objective (economic) factors.

Determinants of propensity to consume are grouped into:

• A. Subjective factors – psychological and institutional motives behind saving and spending.
• B. Objective factors – measurable economic conditions like income, wages, taxes, interest rate, etc.

These factors are related to people’s attitudes, motives, and habits. Most of them increase saving, and therefore reduce propensity to consume.

1) Instinct of miserliness (strong desire to accumulate wealth)

• Some people like to build a large fortune and feel secure only when they have high savings.
• They consciously reduce current consumption and save more, so their propensity to consume is low.

Example: A shopkeeper keeps cutting family expenses so that he can keep adding money to his bank balance.

2) Unforeseen contingencies (precautionary motive)

• People save to face unexpected events like illness, job loss, accidents, or emergencies.
• This precautionary saving reduces present consumption.

Example: A family keeps part of its income aside for medical emergencies instead of spending it on vacations.

3) Desire for self-display and social status

• In modern society, wealth often brings status and recognition.
• Some people limit daily consumption to accumulate wealth, buy status symbols later, or appear “rich” in the long run, which can reduce regular consumption.

Example: An individual avoids small enjoyments now to save for a luxury car that signals high status.

4) Occupational motive (enterprise motive)

• People may save to start or expand a business or profession in future.
• This business motive (enterprise motive) leads them to reduce current consumption.

Example: A salaried person cuts down on entertainment expenses to save capital to open a small restaurant.

5) Farsightedness (planning for the future)

• Sensible people realize that income and health may not remain the same in future.
• To maintain their standard of living in old age or in bad times, they save more today, which lowers current consumption.

6) Desire to leave a fortune for heirs (bequest motive)

• Some people save more so that their children and grandchildren inherit enough wealth to live comfortably.​
• This bequest motive reduces their present consumption.

7) Economic emancipation (desire for economic independence)

• People want to be financially independent and not depend on others or charities in times of need.
• To enjoy this independence, they save more and spend less.

8) Liquidity preference (preference for holding cash)

• Firms and individuals often want to keep some cash (liquid funds) ready to meet emergencies or take advantage of business opportunities.
• Holding more cash can mean less spending on current consumption.

Example: A small firm keeps cash in hand rather than spending it, to manage any sudden fall in sales.

9) Improvement in production techniques

• Business firms may save part of their income to adopt better and more efficient production techniques.
• This reduces current consumption by owners and increases saving for investment.

10) Expansion of business (motive of improvement and growth)

• Firms save profits to expand production capacity, open branches, or enter new markets.
• This reinvestment of profit reduces current consumption by entrepreneurs.

11) Financial prudence (provision for depreciation and replacement)

• Prudent businesspersons set aside funds to replace old machines and cover depreciation and obsolescence.
• Since this money is not spent on consumption, their propensity to consume falls.

12) Modernisation

• To stay competitive, firms save to install modern machinery and technology.
• This again diverts income from consumption to investment.

Objective factors are measurable conditions that can shift the consumption function upward or downward.

1) Changes in income level

• As income of the community increases, consumption also increases, but generally by a less than proportionate amount (Keynes’ psychological law).​
• When income falls, consumption falls, but people try to maintain basic consumption for some time.

Example: If a family’s income rises from ₹20,000 to ₹30,000, consumption may rise from ₹18,000 to ₹25,000, not to ₹30,000.

2) Distribution of income

• If national income is distributed more equally, the propensity to consume is higher because poor and middle-income groups spend a larger part of their income on consumption.
• If income is highly unequal and concentrated with the rich, overall propensity to consume tends to be lower, since rich people save a larger share.

3) Wage and profit levels

• An increase in wages usually raises workers’ consumption, because they have many unmet needs and spend more when income rises.
• Changes in profit affect consumption of business owners; very high profits might increase their consumption, but often a large part is saved or reinvested.

4) Windfall gains and losses

• Unexpected gains (like lottery, sudden rise in share prices, inheritance) may increase people’s consumption temporarily.
• Unexpected losses reduce income and lower consumption.

5) Changes in expectations about the future

• If people expect political instability, shortages, or price rises, they may buy more goods now (stocking up), which increases current consumption.
• If they expect a recession or job loss, they may cut consumption and save more.

6) Fiscal policy (taxes and government spending)

• Higher direct taxes (like income tax) reduce disposable income and tend to reduce consumption.
• Progressive taxation with redistribution and welfare schemes can shift income toward lower-income groups, raising overall propensity to consume.

7) Social security provisions

• When people have pensions, provident fund, insurance, and other social security, they feel safer about the future.
• This may reduce the need for precautionary saving and can increase current consumption.
• However, contributions to PF, insurance, ULIPs, etc., reduce current disposable income, so short-run consumption may fall.

8) Rate of interest

• Classical view: Higher interest rate encourages saving (reward on saving), reducing consumption.
• Keynes: In the short run, effect of interest rate on consumption is relatively weak; in the long run, large changes in interest rates may change social habits and affect consumption.

9) Discovery of new products

• When new products (like smartphones, new gadgets, new services) appear, people want to try them, so their consumption increases.

10) Purchase of consumer durable goods

• If households already own durable goods (TV, fridge, AC, washing machine), their need to buy more of these items falls.
• For some time, their consumption on such items decreases, reducing overall propensity to consume.

11) Attitude to thrift (attitude towards saving)

• In societies where saving is considered a virtue (moral duty), people save more and consume less.
• Where people are more consumption-oriented (Keynesian view: “spending boosts income”), propensity to consume is higher and saving is lower.

12) Wealth and stock of money

• Higher total wealth (houses, land, shares, bank deposits) can increase people’s confidence and encourage more consumption.
• Wealth helps people smooth consumption over time, even if current income fluctuates.

13) Change in real income (price level changes)

• If prices of goods fall while money income remains the same, real income rises; people can buy more, so consumption increases.
• If prices rise, real income falls; people cut down consumption.

14) Liquid assets and Pigou effect (real balance effect)

• According to A.C. Pigou, when prices fall, the real value of cash balances and bank deposits increases.
• People feel wealthier and may spend more, increasing consumption (Pigou or real balance effect).
• Keynes criticised this view, arguing that most people do not hold large cash balances and, even if they do, they may choose to save more rather than spend.

• Subjective factors: Psychological motives like miserliness, foresight, desire for wealth, security, liquidity preference, and business motives affect consumption habits.
• Objective factors: External factors such as income level, income distribution, wages, interest rate, taxes, expectations, and wealth influence consumption.
• Higher income equality, wage rise, windfall gains, and new products increase propensity to consume.
• Higher savings motive, durable goods ownership, and price rise reduce propensity to consume.