Keynes's Psychological Law of Consumption
Keynes’s Psychological Law of Consumption
Keynes promulgated a law standing on the study of consumption function. This law is called the Psychological Law of Consumption or the Fundamental Law of Consumption.
Propositions of the Law
This law consists of the following three related propositions:
(a) When total income amplifies, expenditure on consumption will also augment but by rather less significant amount.
(b) The 2nd proposition is that when revenue increases, the addition of income will be alienated in some ratio between consumption and savings.
(c) The 3rd proposition integrated in Keynes's Psychological Law of consumption is that as revenue increases, both saving and consumption spending will go up.
These 3 propositions form Keynes's Psychological Law of Consumption.
This law is based on the following three assumptions:
1. It is assumed that behavior of the people concerning spending remains constant. In general, the tendency to consume does stay constant. This means that we assume that only revenue changes, while the other variable factors like price movements, income distribution, growth of population, etc., should stay more or less stable.
2. The second assumption is that the circumstances remain common, for example there is no war or hyper inflation and/ or other uncharacteristic circumstances.
3. The third assumption is that of a capitalistic laissez fake economy. In an economy where the State meddles with productive venture, the law can’t be justified.
These assumptions are more or less valid in a short time and in normal conditions. We can, therefore, say that Keynes's Law is a rough approximation to the actual macro behavior of free consumers in the normal short period. It is true that as a rule and on an average, as income increases, consumption will increase, but not by as much as increase in income.
There is one and only one essential characteristic of the slope of the consumption function, viz., and the marginal propensity to consume will be less than unity. It ultimately results in low-consumption and high-saving economy. This law boils down to this that the position and the shape of the consumption function curve depend entirely on income. That is, consumption can be increased only by increasing income.
As the law of assumptions is applied to only normal economic times, there can be a wide range of variables. Normally when a person’s income goes up, they might spend more. But as we saw after the 2008 economic crash and the economic recovery a few years later, people were more likely to save their money than spend it. This was due to fear of another economic downturn and loss of job.
Even while the consumer did not initially spend on consumer goods, they did start to invest again as the stock market went to new highs while interest rates remained near 0%.
When consumption level remains unchanged even with an incremental increase in the income level, the marginal efficiency of capital may decline.