It is a functional relationship between two aggregates i.e., total consumption and National income. Consumption is an increasing function of income. It was developed by John Maynard Keynes

Symbolically, C= f (Y)

Consumption expenditure increases with increase in income.

But increase in consumption is less than increase in income. It is known as Fundamental Psychological Law”.

Consumption Schedule It is the tabular representation of various amounts of consumption expenditure corresponding to different levels of income.

Consumption is basically of two types:

Autonomous Consumption: This is the level of consumption which does not depend on income. The argument is that even with zero income you still need to buy enough food to eat, through borrowing or running down savings.

Induced Consumption: This is that level of consumption which depends on income and varies at different level of income. When income increases, induced consumption also increases.

This function can be written as C= Ca + bY

Where

C= Total consumption

Ca= Autonomous Consumption

By=Induced Consumption (b= Marginal Propensity to consume and Y= income)

                 

                         

Propensity to Consume

Propensity to consume is of two kinds:

  • Average Propensity to Consume
  • Marginal Propensity to Consume

Average Propensity to consume: APC is the ratio of total consumption to total income. It is found by dividing the total consumption with total income.

APC= C/Y

Marginal Propensity to consume: MPC is defined as the ratio of change in consumption to change in change in income. It is found by dividing the change in consumption expenditure with the change in income.

MPC =∆C/∆Y

Characteristics of MPC

  1. It is always positive
  2. It is greater than zero and less than utility
  3. MPC of the poor class is higher
  4. Constant MPC in the long period
  5. Falling MPC in the short period
  6. MPC can be greater than 1 in abnormal conditions

Saving Function

Saving function may be defined as a schedule showing amounts that will be saved at different level of income.

S=f(Y)

Saving increases with increase in income and decreases with decrease in income, i.e., saving is income elastic.

                           

Propensity to Save

Average Propensity to Save: APS is the ratio between total saving (S) and total income (Y) at a given level of income and employment in the economy.

APS= S/Y

Marginal Propensity to Save: MPS is defined as the ratio of change in consumption to change in income. It is found by dividing the change in consumption expenditure with the change in income.

MPS= ∆S/∆Y