Everything about Consumption Function totally explained
In
economics, the
consumption function is a single mathematical function used to express consumer spending. It was developed by
John Maynard Keynes and detailed most famously in his book
The General Theory of Employment, Interest, and Money. The function is used to calculate the amount of total
consumption in an
economy. It is made up of
autonomous consumption that isn't influenced by current income and
induced consumption that's influenced by the economy's income level.
The simple consumption function is shown as the
linear function:
» ::::::::::
C =
c0 +
c1Yd
where
C = total consumption,
c0 = autonomous consumption (
c0 > 0),
c1 = the
marginal propensity to consume (0 <
c1 < 1), and
Yd = disposable income (income after taxes and transfer payments, or W – T). The second term (
c1Yd) is induced consumption.
Autonomous consumption represents consumption when income is zero. In estimation, this is usually assumed to be positive. The marginal propensity to consume (MPC), on the other hand measures the rate at which consumption is changing when income is changing. In a geometric fashion, the MPC is actually the slope of the consumption function.
The MPC is assumed to be positive. Thus, as income increases, consumption increases. However, Keynes mentioned that the increases (for income and consumption) are not equal. According to him, "as income increases, consumption increases but not by as much as the increase in income".
The Keynesian consumption function is also known as the
absolute income hypothesis, as it only bases consumption on current income and ignores potential future income (or lack of). Criticism of this assumption lead to the development of
Milton Friedman's
permanent income hypothesis and
Franco Modigliani's
life cycle hypothesis.
Further Information
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