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Consumption Function

The relationship between private consumption and personal disposable income is called consumption function. Symbolically,

C = f (y)

where, C = Consumption expenditure,

Y = Personal Disposable Income, and

f = Function or depends upon.

It means that consumption expenditure depends upon the level of personal disposable income. Consumer’s spending is related to the amount of income available. Consumption is directly related to money income. As income increase the consumption expenditure also increases.

PHYCHOLOGIAL LAW OF CONSUMPTION

Before the great depression of 1930’s most economists established relationship between consumption (saving) and rate of interest. It was Keynes who, for the first time, explained that consumption depends upon disposable money income. He argued that consumption increases as disposable income increase but by an amount less than increase in income. According to Keynes, “men are disposed, as a rule and on an average, to increase their consumption as their income increased, but not by as much as the increase in their income.” In brief, consumption increase, but not by as much as the increase their consumption increase in a lesser proportion than increase in disposable income. This is called the ‘psychological law of consumption’.

The psychological law of consumption consists of the following propositions:

(1) When aggregate income increases, consumption expenditure also increases but by a somewhat smaller amount. The reason is that as income increase, more and more of our wants get satisfied, and therefore, lesser and lesser amounts are spent out subsequent increase in income.

(2) When income increases, the increment of income will be divided in certain proportion between consumption spending and saving. That part of the disposable income which is not spent on consumption constitutes saving.

(3) As income increases both consumption spending and saving spending will go up. An increase in income is unlikely to lead either to less saving or less spending than before.