Question

Answer the following question.
State the objective factors determining consumption function.

Answer 1

Objective factors, subject to rapid changes and causing violent shifts in the consumption function, are considered below:

 

1. Windfall Gains or Losses:

 

When windfall gains or losses accrue to people their consumption level may change suddenly. For instance, the post-war windfall gains in stock exchanges seem to have raised the consumption spending of rich people in the U.S.A., and to that extent, the consumption function was shifted upward.

 

2. Fiscal Policy:

 

The propensity to consume is also affected by variations in fiscal policy of the government. For instance, imposition of heavy taxes tends to reduce the disposable real income of the community; so its level of consumption may adversely change. Similarly, withdrawal of certain taxes may cause an upward shift of consumption function.

 

3. Change in Expectations:

 

The propensity to consume is also affected by expectations regarding future changes. For instance, an expected war considerably influences consumption by creating fears about future scarcity and rising prices. This leads people to buy more than they immediately need, i.e., to hoard. Thus, the ratio of consumption to current income will rise, which means that the consumption function will be shifted upward.

 

4. The Rate of Interest:

 

In the long run, substantial changes in the market rate of interest may also influence consumption. A significant rise in the rate of interest may induce people to reduce their consumption at each income level, because people will save more in order to take advantage of the high interest rate.

 

Moreover, if the rate of interest rises, then the lending of the present saving (realized by consuming less) will enable one to obtain an even larger quantity of consumption goods in the future. Keynes, thus, argues that “Over a long period, substantial changes in the rate of interest probably tend to modify social habits considerably.”

 

In addition to these four factors, Keynes also mentioned changes in the wage level, in accounting practices with respect to depreciation (indicating the difference between income and net income), as the objective factors affecting the consumption function.