Consumption Function

Question

What is the consumption function?

Answer

The consumption function developed by Keynes shows the relationship between consumer spending and the numerous factors determining it. The consumption formula is C =a + b Yd, Where C is consumption; a is autonomous consumption b is the marginal propensity to consume and (Yd) is the level of disposable income. MPC: Marginal Propensity to Consume, which is the ratio of change in consumption to the change in income, displayed by the formula MPC = ∆C/∆K (Murad, 1964). This model proposes that as income rises, consumer spending will rise. However, spending will increase at a lower rate than income. The model is shown here to be linear, but is dependant on the marginal propensity to consume variable remaining the same. Generally speaking, it is argued that MPC is lower than APC, because consumers tend to spend a smaller portion of additional income when compared of their total average income (Murad, 1964). However, in impoverished communities and significant economic downturns, these two models may yield closer results, as consumers spend every additional dollar they earn in order to meet a basic standard of living. Other theories of consumption include life cycle hypothesis and permanent income hypothesis.

References

Murad, A. (1964). What Keynes Means, New Haven: Bookman Associates Inc and College University Press.