Consumption function
Encyclopedia
In economics
, the consumption function is a single mathematical function used to express consumer spending. It was developed by John Maynard Keynes
and detailed most famously in his book The General Theory of Employment, Interest, and Money. The function is used to calculate the amount of total consumption
in an economy
. It is made up of autonomous consumption
that is not influenced by current income and induced consumption
that is influenced by the economy's income level. This function can be written in a variety of ways, an example being C = a + b(Y-T). This is probably the most simplistic form of the consumption function.
The simple consumption function is shown as the affine function:
where
Autonomous consumption represents consumption when income is zero. In estimation, this is usually assumed to be positive. The marginal propensity to consume (MPC), on the other hand measures the rate at which consumption is changing when income is changing. In a geometric fashion, the MPC is actually the slope of the consumption function.
The MPC is assumed to be positive. Thus, as income increases, consumption increases. However, Keynes mentioned that the increases (for income and consumption) are not equal. According to him, "as income increases, consumption increases but not by as much as the increase in income".
The Keynesian consumption function is also known as the absolute income hypothesis
, as it only bases consumption on current income and ignores potential future income (or lack of). Criticism of this assumption lead to the development of Milton Friedman
's permanent income hypothesis
and Franco Modigliani
's life cycle hypothesis
. More recent theoretical approaches are based on behavioral economics and suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviourally-based aggregate consumption function.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the consumption function is a single mathematical function used to express consumer spending. It was developed by John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
and detailed most famously in his book The General Theory of Employment, Interest, and Money. The function is used to calculate the amount of total consumption
Consumption (economics)
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
in an economy
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
. It is made up of autonomous consumption
Autonomous consumption
Autonomous consumption is a term used to describe consumption expenditure that occurs when income levels are zero. Such consumption is considered autonomous of income only when expenditure on these consumables does not vary with changes in income...
that is not influenced by current income and induced consumption
Induced consumption
Induced consumption is a term used to describe consumption expenditure by households on goods and services which varies with income. Such consumption is considered induced by income when expenditure on these consumables varies as income changes....
that is influenced by the economy's income level. This function can be written in a variety of ways, an example being C = a + b(Y-T). This is probably the most simplistic form of the consumption function.
The simple consumption function is shown as the affine function:
where
- C = total consumption,
- c0 = autonomous consumption (c0 > 0),
- c1 is the marginal propensity to consumeMarginal propensity to consumeIn economics, the marginal propensity to consume is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending occurs with an increase in disposable income...
(ie the induced consumption) (0 < c1 < 1), and - Yd = disposable income (income after government intervention – benefits, taxes and transfer payments – or Y + (G – T)).
Autonomous consumption represents consumption when income is zero. In estimation, this is usually assumed to be positive. The marginal propensity to consume (MPC), on the other hand measures the rate at which consumption is changing when income is changing. In a geometric fashion, the MPC is actually the slope of the consumption function.
The MPC is assumed to be positive. Thus, as income increases, consumption increases. However, Keynes mentioned that the increases (for income and consumption) are not equal. According to him, "as income increases, consumption increases but not by as much as the increase in income".
The Keynesian consumption function is also known as the absolute income hypothesis
Absolute Income Hypothesis
The Absolute Income Hypothesis is theory of consumption proposed by English economist John Maynard Keynes , and has been refined extensively during the 1960s and 1970s, notably by American economist James Tobin .-Background:...
, as it only bases consumption on current income and ignores potential future income (or lack of). Criticism of this assumption lead to the development of Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
's permanent income hypothesis
Permanent income hypothesis
The permanent income hypothesis is a theory of consumption that was developed by the American economist Milton Friedman. In its simplest form, the hypothesis states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term...
and Franco Modigliani
Franco Modigliani
Franco Modigliani was an Italian economist at the MIT Sloan School of Management and MIT Department of Economics, and winner of the Nobel Memorial Prize in Economics in 1985.-Life and career:...
's life cycle hypothesis
Life cycle hypothesis
The Life Cycle Hypothesis is an economic concept analysing individual consumption patterns.The life-cycle hypothesis considers that individuals plan their consumption and savings behaviour over the long term and intend to even out their consumption in the best possible manner over their entire...
. More recent theoretical approaches are based on behavioral economics and suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviourally-based aggregate consumption function.
See also
- Permanent income hypothesisPermanent income hypothesisThe permanent income hypothesis is a theory of consumption that was developed by the American economist Milton Friedman. In its simplest form, the hypothesis states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term...
- Life cycle hypothesisLife cycle hypothesisThe Life Cycle Hypothesis is an economic concept analysing individual consumption patterns.The life-cycle hypothesis considers that individuals plan their consumption and savings behaviour over the long term and intend to even out their consumption in the best possible manner over their entire...
- Consumption (economics)Consumption (economics)Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
- Aggregate demandAggregate demandIn macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
- Measures of national income and outputMeasures of national income and outputA variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product , gross national product , and net national income . All are specially concerned with counting the total amount of goods and...