Question

What part does the consumption function of Keynes play in the theory of employment?

Answer 1

1. Psychological Law of Consumption: Keynes’ consumption function is based on the psychological law that as aggregate income increases, aggregate consumption also increases, but by a smaller proportion. This means people save a part of their income rather than consuming it all. This is fundamental in understanding aggregate demand in the economy.
2. Determination of Aggregate Demand: The consumption function helps explain the level of aggregate demand in the economy. Since consumption forms a major part of aggregate demand, the fact that consumption increases less than income implies that not all output produced is necessarily consumed.
3. Refutation of Classical Say’s Law: The consumption function, by showing the marginal propensity to consume (MPC) less than unity, contradicts Say’s Law (which states supply creates its own demand). This break in classical logic is important because it justifies the existence of involuntary unemployment in Keynes’ framework.
4. Multiplier Effect: The consumption function also underlies the investment multiplier concept, where an initial increase in investment leads to a greater total increase in income and employment due to the induced consumption expenditure.
5. Policy Implications: Since consumption does not automatically rise enough to ensure full employment, Keynes advocated for increased investment and state intervention to boost aggregate demand and employment.