Explain Keynes Psychological Law of Consumption | Psychological law of Consumption

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Keynes psychological law of consumption states that when income increases, consumption also increases but increasing consumption is less than increasing income and the part of income which is not consume is saved.

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Keynes Psychological Law of Consumption

The main basis of consumption function is the psychological law propounded by Keynes. The law implies that there is a tendency on the part of the people to spend on consumption less than the full increment of income.

Assumption of Keynes Psychological Law of Consumption

The Keynes law is based on the following assumption –

(i) This law is based on the assumption that the psychological and institutional complex influencing consumption expenditure remain constant.

(ii) The law is applicable under normal conditions.

(iii) The law operates in a rich capitalized economy, where there is no government intervention.

Propositions of Keynes Psychological Law of Consumption

Let us now the main propositions of the psychological law of consumption, these are explained below –

(a) When income increases, consumption expenditure also increases but by a smaller amount. Symbolically,

ΔC/ΔY < 1 or ΔC < ΔY

(b) As increase in income is divided into some ratio between consumption and saving. It implies that a part of increasing income which is not spent in consumption is saved. Thus, symbolically,

ΔY = ΔC + ΔS

(c) With the increase in income, both consumption spending and saving will either lead to less spending or less saving before. Thus symbolically,

ΔY > 0 then ΔC > 0 and ΔS > 0.

The Keynes psychological law of consumption and the three above mentioned propositions of the law can be understand with the help of following table and diagram –

Table and Diagram of Keynes Psychological Law of Consumption

Income (Y) Consumption (C) (in Rs. Crore) Saving (S) S = Y – C
0 20 – 20
100 110 – 10
200 200 0
300 290 10
400 380 20
500 470 30
600 560 40
700 650 50

In the above table, when income of the community has increased by 300 crore consumption increases by 290 crore and verifying the first propositions which says that when income increases consumption also increases but less than income.

The increases in income by Rs.300 crore is divided in a constant proportion through between consumption and saving, consumption increases by Rs.10 crore with each income increases by Rs.300 crore.

Diagrammatically, it also be explained in the following figure –

Keynes Psychological Law of Consumption
In the above figure, the 45° line is the zero. Saving line because at all points of this line income (Y) = Consumption (C) represents the consumption function which is drawn according to the psychological law of consumption.

It starts not from the origin ‘O’ but from point ‘A’ implying that even when income is zero, consumption is not zero because some basic needs of the people must be satisfied even if the income is zero.

Till point ‘E0‘ as shown in the figure consumption is more than income. The excess consumption expenditure over and above the income level is met up by utilizing previous saving which is called dissaving.

As for example at OY1 (= E1Y1) level of consumption is more than income. The excess of consumption over income is met up by dissaving of the figure S1Y1 (= C1E1). E0 is the break event point of the economy, because at this point consumption equals the level of income.

After this as income increase, consumption will also increase but not at the same part of income which is not consume is saved. In diagram at OY2 (= E2Y2) level of income. Consumption spending C2Y2 (Y2S2) reflects the amount of saving.


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