The Keynesian Consumption Function, Macroeconomics Video Lecture | Macro Economics - B Com

using our circular flow model we see
that households derive income by making
factors of production that they possess
available to firms firms then use these
factors of production to produce goods
and services in return for the use of
these factors of production firms pay
households and this payment we know as
income for most households income
consists of the wages and salaries they
receive in return for their labor
now what the households do with their
income yes we spend most of what we earn
buying goods and services Keynes
describes the relationship between
income and household consumption like
this the fundamental psychological law
upon which we are all entitled to depend
with great confidence both from our
knowledge of human nature and from
experience is that men are disposed to
increase their consumption as income
increases but not as much as the
increase in income in other words for
most of us when we get a pay rise or
salary increase we'll spend more in fact
we'll spend most of that increase but we
won't spend all of it in terms of our
circular flow model we can now add this
spending flow between households and
firms or we know as consumption spending
see now there's a positive correlation
between Y and C higher income causes
higher consumption spending and
vice-versa but it is important to note
that this increase in consumption
spending is usually less than the
increase in income most of us won't
spend every last cent of an increase in
income that comes our way in other words
if the national household income
increases by a hundred million rand
consumer spending will also rise but
only by perhaps eighty million rand so
what happens to the other 20 million
well for the most part households will
save this surplus income and it fits
into our circular flow diagram like this
as a flow of savings so as a general
rule in this model what is not spent is
saved savings is therefore our first
leakage from the spending flow we've
previously used functions to analyze
economic behavior when we looked at
demand and supply we saw that demand was
a function of price income the number of
buyers and so on will now create a
consumption function to help us better
understand our behavior as consumers can
spending see is made up of two types of
spending what we call autonomous
consumption and induced consumption
first what is autonomous consumption
well the most useful definition for us
is that autonomous means independent
autonomous consumption refers to any
consumption that's independent of our
income or what does that mean well if
you think about it even if a household
has no income they'll still be some
basic consumption the family breadwinner
may lose their job and hence their
income but they still have to spend to
survive they'll have to consume some
food wear some clothing find some
shelter they might live off their
savings or loans gifts or handouts or
social programs autonomous consumption
can be regarded as that level of
consumption that takes place even if
income is zero in our equation
autonomous consumption is indicated by C
bar induced consumption is that part of
consumption that does depend on income
as we've seen an increase in income why
causes an increase in consumption
spending C but the increase in
consumption spending is less than the
rise in income this pattern to increase
our consumption spending by less than
any rise in income is shown by the
letter small C and we call this our
marginal propensity to consume this is
an important part of our individual
economic profile our personality and it
plays a key role in the Keynesian model
the value of this marginal propensity is
always less than 1 because consumption
spending increases but by less than
income if the marginal propensity to
consume is 0.9 it indicates therefore
every one R and increase in income
households will increase their spending
by 90 cents so the
consumption function states the
consumption spending see is made up of
autonomous consumption C bar plus
induced consumption which is our
marginal propensity to consume small C
multiplied by our income Y we can
illustrate this consumption function as
a graph the horizontal axis reflects the
level of income Y and the vertical axis
consumption spending C autonomous
consumption C