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Ba llb economics notes pdf psychological Law of Consumption

Ba llb economics notes pdf psychological Law of Consumption

Ba llb economics notes pdf psychological Law of Consumption

In the below post you will read BA LLB economics notes pdf psychological Law of Consumption

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Q.3. State and explain Keynes Psychological Law of consumption.
What are MPC and the APC and how do they differ?
Compare linear and non-linear consumption functions.
Explain the determinants of Propensity to consume.

Ans.                                Psychological Law of Consumption
The consumption function, the relationship between consumption and income, is largely a Keynesian contribution. Keynes postulated that consumption depends mainly on income. In regard to the relationship, he argued that consumption increases as income increases but by an amount less than the increase in income.

It is, however, assumed that by income Kcynės meant the disposable income of the consumer. Keynes designated tendency of consumption varying directly with disposable income as the “Fundamental Psychological Law”.

Açcording to this law, “men are disposed of, as a rule, and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.”, This law is known as “Propensity to Consume’, or Consumption Function.

This law consists essentially of three related propositions:

(a) When aggregate income increases, consumption expenditures also increase but by a somewhat smaller amount. The reason is that as income increases, more and more of our wants get satisfied and, therefore, lesser and lesser amounts are spent out of subsequent increases in income.

(b) The second proposition is that when income increases, the increment of income will be divided in a certain proportion between consumption spending and saving. This follows from the first proposition because what is not spent is saved.

(c) The third proposition is that. as income increases, both consumer spending and saving will go up. An increment in income is unlikely to lead either to less saving or less spending than before. It Would seldom happen that a person decreases his consumption or his saving with an increase in his income. He would spend more than before and also save more than before.

Ba llb economics notes pdf psychological Law of Consumption
Ba llb economics notes pdf psychological Law of Consumption

Assumptions of the Law

Keynes’ Psychological Law of Consumption is based on the following three assumptions:

(a) It is assumed that the habits of people regarding spending do not change or that the propensity to consume remains the same.

Normally, the propensity to consume is more or less stable and does remain unchanged. This assumption implies that only income changes when other factors like income distribution, price movement, growth of population, etc., remain more or less constant. In the short run, these factors are constant or approximately so. In the long run, that may not be true. So the law holds true only in the short period.

(b) The second assumption is that the conditions are normal in the economic system. There is no state of war, revolution, hyperinflation or any other such abnormal condition. The law may not hold good under abnormal conditions.

(c) The third assumption is that of the existence of a capitalistic laissez faire economy. The law may not hold good in an economy where the State interferes with consumption or productive enterprise. The government, for instance, may not permit an increase in consumption With the increase in income.

Explanation of the Law

Consumption (C) is, therefore, according to Keynesian analysis, a function of (determined by) income (Y). This relationship is often algebraically expressed as C = f (Y), where C stands for consumption, function and Y for income. Keynes has made use of four concepts analysing the consumption-in-come relationship. there are:
(1) Average PrOpensity to consume,
(2) Marginal propensity to consume,
(3) Average propensity to save, and
(4) Marginal propensity to save.

A. Average and Marginal Propensities to Consume

The relationship between income and consumption is measured by the average and the marginal propensities to consume. The average propensity to consume (APC) defincs the relationship between the total income and total consumption. It is the ratio of total consumption to Total income. It can be computed for individuals or for all consumers, that is, on an individual or aggregate basis.

Symbolically :           APC = C/Y

where C is aggregate consumption, and Y the aggregate income of the economy. Formally, we define the average propensity to consume as the ratio between total income and total consumption.

While the average propensity to consume is the ratio of totał consumption to total income, the marginal propensity to consume 1s the ratio of the change in total consumption to the change in total income. lf the change in consumption associated with the change in income is denoted as ∆C; and the change in income as Y, the ratio of the change in consumption to the change in income is called the marginal propensity to consume. Symbolically, MPC = ∆C/∆Y

B. Average and Marginal Propensities to Save

The average propensity to save (APS) is ratio of total saving to total income.

Symbolically,            APS = S/Y
APC + APS equal 1. Since income is either consumed or saved,

C +S = Y

then,    C/Y+S/Y=Y/Y= 1

APC+ APS = 1

The APC and APS must add up to one at all income levels. While average, propensity to save (APS) is the ratio of total saving to total income, the marginal propensity to save. (MPS) is the ratio of the change in saving to the change in total income. If the change in saving associated with the change in income is denoted as ∆S, the change in income as ∆Y; the ratio of change in saving to the change in income ∆S/∆Y, is called the marginal propensity to save.
Just as APS and APC add up to 1, in the same way MPC and MPS also add up to 1.

We know that              Y = C +. S

Or                                  ∆Y = ∆C+ ∆S

so                        ∆Y/∆Y = ∆C/∆Y + ∆S/∆Y

Thus,                            1 =  MPC + MPS

and                       1 –  MPC = MPS.

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