Question

‘Logical starting point of Keynes is propensity to consume’. In the light of statement discuss Keynes’ psychological law of consumption function.

Answer 1

Keynes’ Psychological Law of Consumption Function:

Keynes' psychological law of consumption function explains the behavior of consumers with respect to income and expenditure. According to Keynes, “The psychology of the community is such that when aggregate real income is increased, aggregate consumption is also increased, but not by so much as income.”

This means when people's income increases, their consumption increases as well, but the increase in consumption is smaller than the increase in income. People tend to save a part of their additional income instead of spending it all.

Key points of the Psychological Law:

1. Consumption increases with income, but less than proportionately: This implies the marginal propensity to consume (MPC) is positive but less than one. For example, if income increases by 100 units, consumption might increase by only 80 units, saving the remaining 20 units.
2. Income divides between consumption and saving: Any increase in income results in some increased consumption and some increased saving. The formula can be expressed as: [ ΔY = ΔC + ΔS ] where (ΔY ) is the change in income, (ΔC ) is the change in consumption, and (ΔS ) is the change in savings.
3. With a rise in income, consumption and saving both rise: An increase in income will never lead to a decrease in consumption or saving.

Assumptions:

• Psychological and institutional consumption behavior remains stable in the short run.
• The economy is under normal conditions without extreme situations like war or inflation.
• It applies primarily in a capitalist economy with minimal government interference.