Consumption function

The consumption function is an economic equation that describes the relationship between consumption and income. In addition to income, there are other factors such as asset or interest that can be included in the consumption function. There are several assumptions for macroeconomic consumption functions, which differ in terms of the included parameters and in the periods under consideration.

Absolute income hypothesis

The absolute income hypothesis goes back to John Maynard Keynes and is therefore also referred to as the Keynesian consumption function. Thereafter, the consumption depends only on the income of the current period. This reflects his theory differs significantly from the neoclassical theory, where the consumption of past or expected future income depends.

The relationship between the consumption (C ) and income (Y) can be represented as follows:

According to the Keynesian consumption function, income is the only influencing factor, which is also short changed. Keynes attracted a total of 24 factors into consideration, which may affect consumption. This includes the interest rate, which is the main influencing factor in the neoclassical theory.

Keynes mentions a number of other factors influencing the consumption of households. However, since these are not very variable under "normal circumstances " ("normal terms" ) or largely offset in the average household, he neglected these factors for its further theory.

He lists the following factors:

  • The margin between gross and net income
  • The change of assets
  • The change in the time preference
  • The interest rate (though in height and direction hardly a priori determined )
  • The distribution of income
  • The expectation of future income growth.

Other possible factors that it does not consider are:

  • Higher spending or lower revenue in the future ( such as education, pension) with the desire for uniform consumption ( " Foresight" )
  • Lower time preference than the real interest rate: a desire for interest income ( " Calculation" )
  • Desire to continuously increasing consumption ( " Improvement" )
  • Independence of the economy by the state ( " Independence" )
  • Equity for start- ups or speculation ( "Enterprise " )
  • Assets inherited ( " Pride" )
  • Avarice: the negative utility in consumption as such ( " Avarice ").

The gap in Keynes ' theory was closed after the Second World War by the consumer theory of Franco Modigliani, James Duesenberry and Milton Friedman.

Function

The consumption results from the autonomous consumption () and disposable income (Y ) multiplied by the marginal propensity to consume ().

Properties of the consumption function

According to John Maynard Keynes, the consumption function has the following properties:

Example

C = 100 0.8 Y

The autonomous consumption here is 100 units (for example, EUR ). This means that the households to meet their basic needs (eg food) to spend 100 euros, does not matter given how much disposable income (ie even with no income ). The marginal propensity to consume is 0.8. The households spend so from each additional euro 80 cents income on consumer goods and save 20 cents.

On receipt of a disposable income (Y) of 1000 Euro results in the following now: 100 euro anyway be spent on basic needs and 800 € for other consumer goods, 100 euro be saved. This results in a consumption (C ) of 900 euros.

Application

The consumption function is in addition to the investment and government spending component of the demand for goods (also: aggregate demand ) and therefore finds application in the IS function.

Relative income hypothesis

The relative income hypothesis was founded by James Duesenberry and considered in addition to the income of the current period and the previous period of ( n ).

Permanent income hypothesis

In the permanent income hypothesis of Milton Friedman, the consumer behavior oriented to an average value of current and future income expectations. Temporary variation of income thus have little effect on the consumption behavior of households. In this case, interest payments are included.

Life-cycle hypothesis

After the life-cycle hypothesis, which was founded by Franco Modigliani, meet The household consumption decisions based on their expected lifetime income.

Criticism

When looking at the work of Keynes, Duesenberry, Friedman and Modigliani can speak of a progress in the analysis of consumer behavior. While Keynes still assumed that the consumption mainly depends on current income, as well as the future income was included in the consumption function in the subsequent period. Within the present state of research, it is assumed that the consumption of both the current and the expected future income and also have the ability and the interest rates depends.

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