Keynes fundamental law of consumption relates to the MPC. It tells us that men are disposed, as a rule and on the average, to increase their consumption as their income increase, but not by as much as the
increase in their income. From this, we can make two deductions.
increase in their income. From this, we can make two deductions.
Individual (households) generally spend some part of every additional income on consumption. Hence,MPC ≥ 0.
Individuals (households) do not spend all the increase in income on consumption. Hence, MPC ≤ 1 (since C ≤ Y).
It follows therefore that the MPC will always lie between 0 and 1, i.e., 0 ≤ MPC ≤ 1.
In addition, Keynes believed that the MPC tends to decline as we move from the low to the high-income group. In other words, high-income households tend to consume less (and save more) of additional
income than low-income households. Hence the slope of the consumption function falls as we move from left to right.
income than low-income households. Hence the slope of the consumption function falls as we move from left to right.
The standard linear consumption function If we represent the household’s autonomous consumption by a, and the MPC by b, we can rewrite the consumption function for the household as C = a + bY
Where a = autonomous consumption expenditure
b = MPC
This gives us the standard linear Keynesian consumption function. Given a and b and various values of Y, we can derived the level of planned household’s consumption for every level of income (Y). in Fig. 6-2 (panel 1), the consumption function for all households is drawn for a = N500 and b = 0.8
The savings function:
Given that there are no taxes in the system and the business sector is the only consumer of capital (investment) goods, the household can either spend all its income on consumption goods or spend some
and save the rest. Generally, the latter holds true for most households.
and save the rest. Generally, the latter holds true for most households.
Hence, we derive the equation
Y =C + S 6.9
Where Y and C are as earlier defined and S is personal household’s savings. Again, from 6.9 we can derive the equations.
S = Y –C 6.10
C = Y – S 6.11
Household’s savings, like consumption, is a function of household’s income, in general, the higher the income available to households, the greater the capacity to save. Hence, the savings function
(relating savings to income), like the consumption function, will slope upward. However, the savings function will intercept the income (horizontal) axis at a level of income that is equal to the.
(relating savings to income), like the consumption function, will slope upward. However, the savings function will intercept the income (horizontal) axis at a level of income that is equal to the.
The consumption function (panel 1) relates households’ consumption expenditures to income. The savings function (panel II) relates households’ planned savings to income. At households’ equilibrium income level (point e in panel II) households spend all available income (N500) on consumption and current households’ savings is zero. Below this income level, households will dis –save to the extent of the income
deficit needed to finance their autonomous consumption (the difference betweenN500 and the particular income level).
deficit needed to finance their autonomous consumption (the difference between
At point d in panel II, where income is zero, the level of dis-saving is equal to the autonomous consumption expenditure. In other words, households financed the entire autonomous consumption by dis-saving. Beyond point e households saving are positive, i.e., households begun to save a part of every additional income while spending the remaining part on consumption.
Amount needed to finance the household’s autonomous consumption. At this equilibrium level of income,2 household’s income will be equal to planned consumption expenditure and current household’s
savings. In fig. 6-2 (panel II), we present an hypothetical (aggregate) savings function for all households. The function is derived by substituting 6.10 into 6.9, and taking the values of a and b assumed for the consumption function as follows
savings. In fig. 6-2 (panel II), we present an hypothetical (aggregate) savings function for all households. The function is derived by substituting 6.10 into 6.9, and taking the values of a and b assumed for the consumption function as follows
S = Y – a + bY 6.12
S = -a + (I-b)Y 6.13
Where –a = Autonomous savings (saving when income is zero) and 1 – b = MPS.
Alternatively, we can state that
S = -a + sY 6.14
Where s = 1 – b
Substituting a = 500 and b = 0.8 into 6.13, we have
S = -500 + 0.2Y 6.15
The Average Propensity to Save (APS)
The average propensity to save (APS) describes the fraction of a unit of income that is saved by the household. Algebraically,
APS = S/Y 6.16
Similarly, the marginal propensity to save (MPS) shows the fraction of every additional income that is saved.
MPS = S/Y 6.17
Again, the MPS increases as we move from low to high-income households. If what is not consumed is saved, then the sum of household’s APC and APS should equal unity. If for example, Y = 500, C = 300
and S = 200, APC C/Y = 0.6 and APS = 200/500 = 0.4. Hence,
and S = 200, APC C/Y = 0.6 and APS = 200/500 = 0.4. Hence,
APC + APS = 1
Similarly, if a given fraction of an additional unit of income is spend on consumption and the remaining part is saved, then
MPC + MPS = 1
If income increases by N100, for example, and C increases by N80 while S increase by N20,
the MPC = 80/100 = 0.8, MPS = 20/100 = 0.2, and MPC+ MPS = 0.8 + 0.2 = 1.
the MPC = 80/100 = 0.8, MPS = 20/100 = 0.2, and MPC+ MPS = 0.8 + 0.2 = 1.
Finally, given 6.19, we can state the MPC in terms of the MPS and vice versa as follows
MPC = 1 – MPS
MPS = 1 – MPC
