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Revision:Determinants of Consumption

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TSR Wiki > Study Help > Subjects and Revision > Revision Notes > Economics > Determinants of Consumption


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:

C = CO + bY

where:

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


  1. MPC: Keynesian view is that when income increases, Cons increases, but by less than Y, which implies that mpc
  2. APC: proportion of income consumed (\frac{C}{Y} = apc) will tend to fall as Y increases.
The positive constant CO above ensures this will happen, since: apc = C = CO^* + b
^* : +ve constant.
But – this will only happen if CO is positive. This implies:
  1. apc > mpc by \frac{CO}{Y}.
  2. If consumption function is a straight line: assuming constant mpc.
  3. APC: found by measuring slope of radian to appropriate point of consumption function = tangent of α.
  4. Can be seen that as Y increases, apc (\frac{C}{Y}) decreases. I.e. as income increases, the proportion of income consumed falls (even with constant mpc \to CO).
  5. 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 < 1, CONSUMPTION would \Delta by less than the \Delta in disposable income.

(Empirical Point: How to derive a consumption function)

(How to find CO and b) – 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 - \Delta in real consumer expenditure

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

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


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