Keynes' Psychological Law of Consumption

Keynes' Psychological Law of Consumption

            Keynes' psychological Law of Consumption is an important tool of economic analysis in Keynesian economics. Keynes propounded the fundamental psychological law of consumption which forms the basis of the consumption function. 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. Therefore, this law is called fundamental law of consumption or psychological law of consumption. In other words, the law states that aggregate consumption is a function of aggregate disposable income. According to Keynes, consumption function shows the functional relationship between income and consumption. It explains the nature of propensity to consume. According to this law, people have a tendency to spend more on consumption when their income increases, but consumption expenditure won't increase by same extent as increase in income, because a part of increased income is saved. This law states that, "The psychology of the community is such that when aggregate real income is increased, aggregate consumption is increased, but not by so much as income". The psychology of the community is determined by people's habit, custom and tradition. This law way popularly known as 'propensity to consume' and subsequent writers called it 'consumption function'.

            Keynes' psychological law of consumption depends upon three related propositions:

(i)   When the aggregate income increases, consumption expenditure will also increase by a somewhat smaller amount;

(ii)  An increment of income will be divided in some ratio between saving and spending;

(iii) An increase in income is unlikely to lead either to less spending or less saving than before.

            Above given all the propositions of this law means that consumption essentially depends upon income and that income receivers always have a tendency to spend less on consumption than the increment in income.

Assumptions

Keynesian psychological law of consumption is based on the following assumptions:

(i)   Short-period: This law is related to the short-run because in the short-run distribution of income, price level, population growth, fashion, tastes, behaviour, etc., won't change. Consumption will only depend upon income.

(ii)  Normal Situation: There should be a normal situation in the economy for the application of this law. In such a situation, war, revolution, hyperinflation, etc., should not be occur.

(iii)      Laissez-faire Capitalistic Economy: It assumes the existence of a laissez-faire capitalistic economy. It means, this law only operates in a developed capitalistic economy where there is not any kind of government interference. That is, this law won't be applicable if government intervention occurs.

            The main proposition of Keynesian psychological law of consumption can be illustrated by the following hypothetical consumption schedule:

Schedule of Consumption and Income

[Rs. in Crores]

Income (Y)	Consumption (C) C=f(y)	Saving (S) S=Y-C
100	70	30
120	80	40
140	90	50
160	100	60
180	105	75
200	110	90

            In above table, when income increases, the consumption also increases but less than income. When income increases from Rs. 100 crores to Rs. 120 crores, then consumption expenditure also increases from Rs. 70 crores to Rs. 80 crores. It means that income in creased by Rs. 20 crores but consumption increased by Rs. 10 crores only, because of some part of increased income is saved.

Diagrammatically presentation of the law

            In the figure, when income increases from OY_0­ to OY₁, Consumption also increases from EY₀ to C₁Y₁, but the increase in consumption is less than the increase in income, i.e., C₁Y₁<CY. Similarly, when income increases from OY₁ to OY₂, consumption also increases from C₁Y₁ to C₂Y₂ and increased saving A₂C₂>A₁C₁.

            Thus, Keynesian psychological law of consumption explains about the psychology of community towards expenditure pattern that the consumption function measures not only the amount spent on consumption but also the amount saved.