Consumption and its Determinants

Consumption:

It is the act of spending income for purchasing goods and services to satisfy current wants. In other words, it means the total expenditure made by consumers in the purchase of goods and services.

Consumption Function:

It is the quantitative relationship between consumption and disposable income.

Mathematically:

C=f( Yd, W, Ye, P, I )

C= Consumption         Yd= Disposable income

W= Wealth                   Ye= Expected future income

P= Price level                I= Interest rate

The above function can be written simply as:

C= f(Yd) because disposable income is the most influencing determinant out of the other determinant

Consumption function in the linear form can be written as: C=a+bYd

Determinants of Consumption

Keynes has divided the factors influencing the consumption into two categories:

a. Objective factors

i. Income of the People

There is positive relationship between income and consumption.

ii. Income Distribution

If there is large disparity between rich and poor, the consumption is low because rich people have a low propensity to consume than poor people. It there is equal income distribution then there is high propensity to consume.

iii. Price Level

When the price level falls, people will consume more and propensity to consume of the society increases.

iv. Wage level

Increased wage level has the direct effect to the consumption which increases the propensity to consume in the society.

v. Interest Rate

Higher rate of interest induces people to save more and reduces consumption.

b. Subjective Factors

i. Security Motive

People save more for unforeseen and future needs which ultimately decreases the consumption in the present time.

ii. Demonstration Effect

People in lower and middle class income groups imitate the life style or consumption pattern of higher income class people which ultimately increase the consumption.

iii. Increasing Social Status

People are motivated to save more and accumulate large wealth which will increase their social status and helps to reduce consumption.