Revision:Determinants of Consumption

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Keynesian Absolute Income Hypothesis

Main influence on consumption in SR = Current

(Developed in General Theory) Disposable Income

(NB: This is a ‘generalised’ version of the Keynesian Consumption Function as it uses total income rather than disposable income as the independent variable)

Keynesian Consumption Function usually expressed as:

where:

• = Consumer expenditure;
• = a constant;
• = (mpc) marginal propensity to consume (amount consumed out of last pound received);
• = National Income.

1. MPC: Keynesian view is that when income increases, Cons increases, but by less than , which implies that mpc
2. APC: proportion of income consumed () will tend to fall as increases.

The positive constant above ensures this will happen, since:

 : +ve constant.

But – this will only happen if is positive. This implies:

3. by .
4. If consumption function is a straight line: assuming constant mpc.
5. APC: found by measuring slope of radian to appropriate point of consumption function = tangent of α.
6. Can be seen that as increases, apc () decreases. I.e. as income increases, the proportion of income consumed falls (even with constant mpc ).
7. Effect of SR fluctuations of current disposable income: as aforementioned: for Keynes, main influence on consumption in SR was current disposable income.

When this fluctuated, so would consumption, but because mpc , CONSUMPTION would by less than the in disposable income.

(Empirical Point: How to derive a consumption function)

(How to find and ) – fit a regression line/line of best fit (best fit in sense that it minimises the sum of squared deviations from line)

From a data table showing - real consumer expenditure - personal savings ratio

- real personal disposable income - in real consumer expenditure

And from that (over a time period), derive apc, mpc.

(UK data over the past 40 years suggests that vertical intercept ~ not significantly diff from zero. If it failed to go through origin – would mean that apc does not fall as rises)

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