Question

Explain Keynes's psychological law of consumption function with a diagram.

Answer 1

Proposition (1):
Income increases by ₹ 60 crores and the increase in consumption is by ₹ 50 crores.

Proposition (2):
The increased income of ₹ 60 crores in each case is divided in some proportion between consumption and saving respectively, (i.e., ₹ 50 crores and ₹ 10 crores).

Proposition (3):
As income increases consumption as well as saving increase. Neither consumption nor saving has fallen. Diagrammatically, the three propositions are explained in the figure. Here, income is measured horizontally and consumption and saving are measured on the vertical axis. C is the consumption function curve and 45° line represents income consumption equality.

Proposition (1):
When income increases from 120 to 180 consumption also increases from 120 to 170 but the increase in consumption is less than the increase in income, 10 is saved.

Proposition (2):
When income increases to 180 and 240, it is divided in some proportion between consumption by 170 and 220 and saving by 10 and 20 respectively.

Proposition (3):
Increases in income to 180 and 240 lead to increased consumption 170 and 220 and increased saving 20 and 10 than before. It is clear from the widening area below the C curve and the saving gap between 45° line and C curve.