Question

Explain the Keynesian psychological law of consumption.

Answer 1

According to Keynes’ psychological law of consumption, although with the increase in the income, the consumption expenditure increases, however, this increase in the consumption is less than the increase in the income. In other words, the rate of increase of consumption is lesser than the rate of increase in income. This is because the consumers do not spend the whole of the increase in their income on consumption. Rather, a part of the increase in the income is saved. Thus, the proportionate increase in the consumption is less than the proportionate increase in the income.

Answer 2

Psychological Law of Consumption:

The Keynesian concept of consumption function stems from the fundamental psychological law of consumption which states that there is a common tendency for people to spend more on consumption when income increases, but not to the same extent as the rise in income because a part of the income is also saved. The community, as a rule, consumes as well as saves a larger amount with a rise in income.

The Keynes’ consumption function can be expressed in the following form:

C = a + bY_d

where C is consumption expenditure and

Y_d is the real disposable income which equals gross national income minus taxes,

a and b are constants, where a is the intercept term, that is, the amount of consumption expenditure at zero level of income.

Thus, a is autonomous consumption.

The parameter b is the marginal propensity to consume (MPC) which measures the increase in consumption spending in response to per unit increase in disposable income.

Thus

MPC = ∆C/∆Y