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What is Consumption function and factors which influences the consumption function?


Posted Date: 04-Mar-2010  Last Updated:   Category: Education    
Author: Member Level: Gold    Points: 15


What is Consumption function; Factors which influences Consumption function;



Definition:
Consumption function refers to the functional relationship between aggregate consumption and aggregate income C = f(y). The schedule shows the various amount of consumption at various levels of income. This shows that when income increases, consumption also increases, but in a lesser proportion (i.e.) the proportion of income spent on consumption goes on falling as income increases. A part of additional income is not consumed and is therefore saved. As a result of the increase in national income -

(a) Consumption expenditure increases at a diminishing rate.
(b)Savings increases at an increasing rate. This show that as income increases, propensity to consume increases in a lesser proportion and propensity to save increases, in a greater proportion.

(A) Objective factors influencing the consumption function:

  • First of all the households consumption expenditure depends on their income level. The consumption expenditure can be partly autonomous and partly dependent on disposable income. Disposable income is income minus personal or direct taxation. Thus C = f (Yd) where C = Consumption, Yd = disposable. Keynes psychological law status that as income increases, consumption also increases - but less than proportionately. Every increased income is generally divided into consumption and savings.

  • Secondly consumption depends upon the distribution of national income. If the national income is properly distributed, then people's income that is the per capita income will be high and they will consume more.

  • Price level:
    The consumption pattern of the individuals not only depend upon the money income, but also the price level. Thus, during inflation, their consumption power is less and vice versa.

  • Wages:
    The consumption pattern largely depends upon the wages also, whether their remuneration is received in the form of cash or in kind.

  • Unexpected profits and losses:
    If the individuals are self employed people or business man, then their consumption pattern mostly depends on their profit and loss. Unexpectedly, if they gain more, then their consumption pattern is high.

  • Liquidity preference:
    If people prefer to hold more and more liquid cash, then their present consumption will be low.

  • Rate of Interest:
    If the interest is high, then people will forgo the present consumption and postpone it for a future date. Higher the rate of interest payable, lesser will be purchasing power. This will certainly reduce the consumption.

  • Future expectations:
    If the demand for cash to make speculative gains is more, then the present consumption will be low.

  • Permanent income:
    The people who have permanent income either from earned or unearned income, there consumption will be more.

  • Advertisement:
    If the advertisement and publicity can induce the people more effectively, then the consumption of the people for such commodities will be more.

  • Credit facilities:
    If goods can be purchased by taking loans, individuals spend more on consumption.


(B) Subjective factors influencing consumption function:
There are some psychological motives which encourage savings and discourage consumption.
They are as follows:

(a) Motive of precaution: The desire to save for meeting unforeseen emergencies in future.
(b) Motive of foresight: The desire to build reserves for meeting old age needs.
(c) Motive of calculation: The desire to save for earning interest.
(d) Motive of improvement: The desire to save for future progress.
(e) Motive of independence: The desire to save for attaining self reliance.
(f) Motive of pride: The desire to save for possessing wealth.
(g) Motive of enterprise: The desire to save for establishing business assets.

Motive which encourage savings among corporate sector:

(a) Motive of enterprise: The desire to create additional resources for further investment.
(b) Motive of liquidity: The desire to keep more liquid assets for meeting future emergencies.
(c) Motive of improvement: The desire to enjoy rising income.
(d) Motive of financial prudence: To arrange sufficient funds against depreciation.

So by this factors we completed with the whole section of Consumption function.

Thank you.


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