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Consumption Function Consumption Consumption Function Consumption

Consumption Function Consumption - PowerPoint Presentation

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Consumption Function Consumption - PPT Presentation

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

factors income apc keynes income factors keynes apc data hypothesis consumption run studies family mpc relationship keynsian amp long

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Slide1

Consumption Function

Slide2

Consumption 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”

Slide3

He 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

Slide4

Thus 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

Slide5

The 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

.

Slide6

This 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

Slide7

If 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

Slide8

According 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

Slide9

Keynes 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

Slide10

Subjective 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

Slide11

Objective 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

.

Slide12

Propensity 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.

Slide13

2- 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.

Slide14

45°

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