Function CF Greater part of Chapter 8 amp 9 of the General Theory are devoted to factors which underlie CF and determined its form ie slope and position of the curve One section ID: 919258
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Slide1
Consumption Function
Slide2Consumption Function (CF)
Greater part of Chapter 8
&
9 of the General Theory are devoted to factors which
underlie CF and determined
its form i.e. slope and position of the
curve
One section
devoted
to factors which cause shift in
CF
According
to Classical
Ects
.
c
onsumtion
was an inverse
function
of (
r)
Keynes
advanced the hypothesis that consumption depends primarily on real
income - as
real income ↑
es
, cons. will also
↑
Keynes propounded
CF in
terms of “Fundamental Psychological
Law of Consumption”
Slide3He said “men are disposed, as a rule and on the average, to increase their consumption as their income increases but not by as much as the
increase
in
income”
Thus
according to Keynes, when
Y
↑
es
, C will also ↑ but ↑ in C
< ↑
in
Y i.e
.
Δ
C
<
Δ
Y or MPC
is positive but less than one i.e. 0 < MPC <
1
Keynes further
argued, though with less
confidence
, that as income ↑
es
proportion of
Y
allocated to consumption
C/Y ↓
i.e. as
Y↑es
,
APC
↓
By income Keynes meant disposable
income
Slide4Thus elements of Keynsian
hypothesis are:
C varies directly with Y
0 < MPC < 1
As
Y ↑
es
,
C/
Y↓
es
A
no.
of
forms
can satisfy this hypothesis but let us consider a
relationship
C = a +
bY
(a > 0, 0 < b < 1)
a
& b are constants called
parameters-
equ
indicates
C
is a linear form of
Y
Here a shows autonomous cons and b induced cons. b is MPC =
Δ
C/
Δ
Y
Linearity
is assumed because empirical evidence suggests that
CF is
linear or approximately
so
Slide5The following diagram shows Keynsian
CF
45°
C
= a +
bY
C
O
Y
0
Y
In the above diagram C =
a+bY
depicts
Keynsian
CF
It
shows that MPC is positive but < 1, and as Y ↑
es
C/Y i.e. APC ↓
es
. At income Y
0
APC = 1 below Y
0,
APC > 1 and above Y
0
, APC < 1
It shows that APC ↓
es
as Y ↑
es
.
Slide6This implies that proportion of income that is saved ↑
es
with ↑ in N.I
.
This result also follows from the studies of family budgets of various families at different levels of income
.
This
CF
implies that to achieve and maintain
equ
.
at full empt. ↑ing
proportion of N.I. is to be invested If sufficient invt
. opportunities are not available, economy would run into trouble and it will not be possible to maintain full
empt. because A.D. will fall short of full empt. level
Earlier studies based on cross-sectional budget studies appeared to confirm this relationship
These budget studies show a relationship between family C and family
Y
like that which Keynes postulated for the
economy
Slide7If a straight line is fitted to the data by regression analysis or some other technique, the line interests vertical axis at a positive level consumption and has a slope ranging between 0.6 to 0.8
Factors
determining
CF
:
Keynes divided
factors
determining
CF
in two groups:
Subjective
Factors, (endogenous)Objective
Factors (exogenous or external to the economic system)
Subjective factors include:Psychological characteristics of human nature,
andSocial practices and institutions, (specially the behaviour pattern of business concerns w.r.t. wage and dividend payments and retained earnings), and social arrangements such as those affecting distribution of income
Slide8According to Keynes, subjective factors are unlikely to undergo a material change
over
a short period of time except in abnormal or revolutionary
circumstances
-
likely to be fairly stable.
These are
slowly changing
factors, fundamentally
determine slope and position of C.F. and serve it to give a family high degree of
stability
External
factors may undergo rapid change and may cause marked
shifts in the CFAmong subjective factors are included those factors which induce and prompt people to
save
Slide9Keynes lists 8 such motives:
Building of reserves
for
unforeseen contingencies.
Provision for anticipated future
needs
Desire to enjoy
an enlarged
future income by investing funds out of
current income
Enjoyment of a sense of independence and power to do
things
To carry out speculation or business
project
Bequeathing a fortune, and
Satisfaction of pure miserliness – accumulation of wealth give them a greater psychic satisfaction
Slide10Subjective factors also apply
to
behaviour pattern of
business
corporations and
governmental bodies
Keynes
listed
four motives
for
accumulation
by bus. corporations & govt.,
Enterprise – the desire to do big things to expand
Liquidity – the desire to face emergencies successfullyRising incomes – the desire to demonstrate successful
managementFinancial Prudence – the desire to ensure, adequate financial provision against depreciation and obsolescence and to discharge debt.
Keynes laid great stress on behaviour of bus. concerns w.r.t. depreciation & other reserves and how these practices affect amount of C in relation to Y
Slide11Objective Factors:
Keynes lists six objective factors which may cause substantial shifts in
CF
Windfall gains or losses
Changes in General Price Level and wage levels ↑ P => ↓ Shift in C.F. through RBE
Changes in Fiscal Policy – ↑ T => ↓ MPC
Changes in expectations
Substantial changes in (r)
Changes in accounting practices w.r.t. depreciation etc
.
Slide12Propensity to consume does not change, generally, in the short-run because it depends more on psychological and institutional factors which change only in
long-run
Therefore, Keynes was of the view that
CF remains
stable in the
short-run
Because of focus on the observed income as driving force behind consumption,
Keynsian
CF is referred to as Absolute Income Hypothesis.
Earlier
Keynsians
were enthusiastic about CF
analaysis for two reasons:
1- If a stable relationship between C & Y exists, amount of Invt.,govt. purchases and taxes necessary to achieve full empt. Can be determined.
Slide132- Earlier studies based on cross sectional budget studies appeared to confirm relationship between family C and family Y as postulated by Keynes for the economy.
If a straight line is fitted to the data by regression analysis or some other technique, line intersects vertical axis at a positive level of C and has a slope ranging between 0.6 to 0.8
.
Keynsian
hypothesis of ↓
ing
APC with rise in income has not been borne out in
practice in the long run
In 1946,
Simonn
Kuznet in his empirical study of Time Series Data of U.S. during period 1869-1938, has found that despite continued growth in real income or
GNP, APC has not ↓ed and APS has not ↑
Kuznet found that APC has remained almost stable or constant throughout this long-period - estimated to be around 0.9Therefore
long-run C.F. is linear of the form C = bY implying that C was approximately zero when Y is zero i.e. CF. passes through the
origin.
Slide1445°
c = by
C
Y
Kuznet’s long-run
CF
shows that there is proportional relationship between C & Y i.e. long-run APC is constant and
MPC
= APC and both are
constant
This
is contrary to Keynes’ theory of
CF
and also
contradicts
findings of cross-sectional family budget studies
,
became a puzzle for
ects called “Consumption Puzzle
Slide15→ Two types of data were used to test
Keynsian
absolute income hypothesis i.e. (
i
) Cross-section data (ii) Time-section data
Cross section data reflect the relative behaviour of a group of individuals at some point of time. Time series data capture the pattern of aggregate behaviour or a time span
.
Later on, theories of C.F. succeeded in resolving this
puzzle. Important theories resolving cons.
p
uzzle are as follows;
1- Life
Cycle Hypothesis – Franco
Modigilani
2 - Permanent Income Hypothesis – M. Friedman3 - Relative Income – James Dusenbry