Question

Show Keynes’ psychological law of consumption along with assumptions, schedule and diagrams.

Answer 1

1. Constancy in Psychological-Institutional Complex: Consumption behavior remains stable in the short period. This means that the psychological and institutional factors influencing consumption do not change suddenly.
2. Normal Conditions: The law assumes that the economy is operating under normal conditions. Abnormal conditions like war, inflation, or deflation are considered nonexistent or irrelevant for the law’s applicability.
3. Rich Capitalist Economy based on Laissez-faire: The law holds true in a capitalist economy with minimal government interference. The environment assumed is one where markets operate freely.

Tabular Representation

Income	Consumption	Saving
0	40	-40
100	100	0
200	150	50
300	190	110
400	220	180
500	240	260
600	250	350

Diagrammatic Representation

In the figure, income is shown on the X-axis, while consumption and saving are shown on the Y-axis. The 45° line represents the situation where income equals consumption (Y = C) at every point.

At the income level OY, point E represents the break-even point, where consumption is exactly equal to income, and there is neither saving nor dissaving.

When income is at OY₀, consumption is E₀Y₀, which is greater than income by the amount E₀P₁. This excess of consumption over income is called negative saving or dissaving, and it equals S₀Y₀.

At a higher income level Y₁, the consumption expenditure E₁Y₁ is less than income Y₁P₂ by the amount P₂E₁, which represents savings, also shown as S₁Y₁ , this is referred to as the saving gap.