Introduction to a theory of the consumption function. Testing theories of consumption behavior using information on. Asee 2014 zone i conference, april 35, 2014, university of. The aggregate demand comprises consumption, investment and government expenditure.
Our theory emphasizes the importance of the relative income hypothesis and debt finance for understanding household consumption behavior. At its simplest, the module collects data on how much people spend on various goods and services. Pdf the estimation of aggregate consumption function for. Aggregate demand and aggregate supply do not necessarily cross at full employment level fig. Aggregate expenditures on investment, i, government, g, and net exports, nx, are typically regarded as autonomous or independent of ception is aggregate current income. Keynes was the first economist to introduce the concept of consumption function namely psychological law. Unesco eolss sample chapters social and economic development vol. A theory of aggregate supply and aggregate demand as. Middleaged people tend to have higher incomes with lower propensities to consume and higher propensities to save. The concept of consumption is one that varies between the academic community, governments, and between individuals. It is shown that particular importance attaches to how net debtor households service their debts, and that the treatment of debtservicing commitments as a.
Consumption is a function of the current absolute level of income. Thus duesenberrys theory provides a convincing explanation in terms of demonstration and ratchet effects why aggregate consumption function is linear rather than nonlinear. Household debt and aggregate consumption expenditures by. Theories on consumption there are many different theories on income and consumption behavior, and we will focus on some of the more mainstream concepts in consumption theory. The functional relationship between the aggregate consumption expenditure and aggregate disposable income is known as the aggregate consumption function, all else equal. Explaining keynes theory of consumption, and assessing. Aggregate and cross section jean crocketf university of pennsylvania ii is the thesis of this paper that we have so far been unable to measure accurately the effects on consumption either of the predominantly important factor, income, or the secondarybut still important factor, assets.
The average propensity to consume is higher in young and old households, whose members are either borrowing against future income or running down lifesavings. Notice that the horizontal axis is now expressed in terms of wage units, so that the more. Keynes argues that aggregate consumption expenditures are determined primarily by current real national income. Y1 f x where y1 aggregate consumption expenditure, x aggregate disposable income.
Generalized linear consumption function video khan academy. If money demand depends on disposable income, however, then the tax cut increases money demand, so the lm curve shifts upward. The concept is believed to have been introduced into macroeconomics by john maynard keynes in 1936, who used it to develop the notion of a government spending multiplier. Our theory emphasizes the importance of the relative income hypothesis and. A theory of aggregate supply and aggregate demand as functions of market tightness with prices as parameters pascal michaillat and emmanuel saez february 16, 20 abstract this paper presents a parsimonious equilibrium business cycle model with trade frictions in the product and labor markets. Franco modigliani and the life cycle theory of consumption. First, aggregate consumption determines aggregate saving, because saving is defined as the portion of income that is not consumed. At the empirical level, data shows that population age distribution affects aggregate consumption and savings. How well do alternative labor market theories explain variations in net job creation. In his an inquiry into the nature and causes of the wealth of the nations, adam smith declared that consumption was the sole end and purpose of production. Consumption differs from consumption expenditure primarily because durable goods, such as automobiles, generate an expenditure mainly in the period when they are.
Government consumption expenditures and the current. Despite the foundational place occupied by consumption in smiths vision, he did not develop a comprehensive economic theory of consumption. Gregory mankiw department of economics, harvard university, cambridge, ma 028 this article reexamines the consistency of the permanentincome hypothesis with aggregate postwar u. Begin with a basic pointslope form of the consumption function where a is a proxy for aas and becomes the y intercept and mpc is the slope. According to the quantity theorists, an increase in the money supply leads to an increase in the aggregate demand.
It is not expected that the reader will find here an analysis that is completely satisfying, merely one that may be suggestive. Average propensity to consume is described as the proportion of income that goes to consumption. Read this article to learn about the keynes income and expenditure theory. The dependence structure of the population influences consumption pattern. An important postkeynesian theory of consumption has been put forward by modigliani and ando which is known as life cycle theory. Asee 2014 zone i conference, april 35, 2014, university. Consumption, in economics, the use of goods and services by households. Consumption is, or shall be defined to be, the total quantity of goods and services that. But aggregate consumption and aggregate investment should be a ected by di erences of opinion amongst investors in the nancial market.
Clearly the linear keynesian consumption func tion was insufficient, since it could not explain why the mpc was less than the apc in the short run and across households, yet aggregate consumption was proportional to income over the long run. Keynes was not interested in the factors determining the aggregate. The major theories of consumer behaviour can be grouped with a economic theories, b psychological theories c psychoanalytical theories and d socio cultural theories. In economics, the consumption function describes a relationship between consumption and disposable income. Measured in terms of aggregate growth rates, development has been a great success. But measured in terms of jobs, justice and the elimination of poverty, it has been a failure or only a partial success. The discussion found in it should be regarded as tentative rather than final, and as frag mentary rather than comprehensive. Because aggregate saving feeds through the financial system to create the national supply of capital, it follows that aggregate consumption and saving behaviour has a powerful influence on an economys longterm. It is generally understood that debt accumulation is the yin and yang of real economic expansion in postkeynesian macroeconomics palley 1996. Testing theories of consumption behavior using information on aggregate shocks.
A theory of aggregate consumption request pdf researchgate. Inequality and macroeconomics princeton university. The basic idea is that aggregate demand will adjust to supply, and that value theory and distribution will reflect this rational, cost of production model. This theory also argues that consumption is directly but not proportionately related to the current level of aggregate disposable. The next phase was the observation that consumer goods demonstrated a relative value based on utility, which could deviate from consumer to consumer. Before exploring the various theories on consumption determination, therefore, it must be explained what consumption entails. The early postwar theories that were devised with this paradox in mind eventually led. The relation between aggregate consumption or aggregate savings and aggregate income, generally termed the consumption function, has occupied a major role in economic thinking ever since keynes made it a keystone of his theoretical structure in the general theory.
Its simplest form is the linear consumption function used frequently in simple keynesian models. Using five year moving averages of consumption spending, kuznets 1946 showed that long run time series consumption data for the u. The consumption function munich personal repec archive. Testing theories of consumption behavior using information. The old quantity theory of money is weak in that it establishes a direct relationship between the money supply and the aggregate demand. Why the aggregate supply curve is vertical in the long run b. The main point of my talk macroeconomics and inequality is a twoway street inequality macroeconomy 1. The below mentioned article provides notes on consumption function. We are now in a position to contemplate exactly how borrowing and debt accumulation affect aggregate consumption. General theories of consumption function a complete guide. The combination of lowfrequency, highstakes decisions e. Debt usage determines the opportunity cost of consumption or investment for most households. Put simply, people have infinite needs and the market will selfcorrect to the aggregate demands and available resources.
Keynes related consumption to current disposable income 1, and for many years this was widely accepted. This pdf is a selection from an outofprint volume from the national. When the value of aggregate demand exceeds the value of aggregate supply at the full employment level, the inflationary gap arises. There is no doubt that aggregate consumption is a key variable for policy makers. Given the aggregate supply, the level of income or employment is determined by the level of aggregate demand. Consumption is distinct from consumption expenditure, which is the purchase of goods and services for use by households. Major theories in macroeconomics boundless economics. Explaining keynes theory of consumption, and assessing its. Disposable income refers to the total amount of income available for use by households or the after tax personal income. The larger the gap between aggregate demand and aggregate supply, the more rapid is the inflation. The aim of this handbook is to familiarise the reader with the key theories that.
Theories of savings and economic growth sciencedirect. Vii economic theories of consumption roberta sassatelli encyclopedia of life support systems eolss economic theories of consumption roberta sassatelli school of economic and social studies, university of east anglia, norwich, uk and department of communication. The theory of determination of national income is concerned with finding out the equilibrium level of national income, i. These theories state that current spending by households should reflect all available information so that future changes in spending are unpredictable. Keynesian theories of growth 123 advocate protectionism as a remedy against recession, a provocative suggestion in a laissezfaire oriented environment keynes, 1929, pp. If all consumers have the same behaviour, the aggregate consumption function is. Development thus became synonymous with rapid, aggregate economic growth. In the united states, government expenditure on hours has accounted for a substantial share of government consumption expenditure, as illustrated in figure 1b. Consumption is the most important single element in aggregate demand, so that its accurate estimation is essential to the management of the economy. Keynes took it for granted that current consumption expenditure.
Aggregate theory is a theory of partnership taxation in which a partnership is considered as an aggregate of individual coowners who have bound themselves together with the intention of sharing gains and loses. The keynes income and expenditure theory economics. People save primarily to provide for consumption during their retirement years. This linearstages approach was largely replaced in the 1970s by two competing economic and indeed ideological schools of thought. The relation between aggregate consumption or aggregate savings. It is generally assumed that there is no correlation.
This therefore implies that the average propensity to consume apc declines with increase in income. We fully generalized our consumption function and now weve written it as a function of aggregate income, not just aggregate disposable income. Consumption functions the kuznets paradox posed a challenge for theoretical modelers of consumption. In the wake of the publication of the general theory keynes theory of aggregate consumption spending was quickly adopted, but it was soon confronted by an. The consumption function, or keynesian consumption function, is an economic formula representing the functional relationship between total consumption and gross national.
The first, which focused on theories and patters of structural change, used. Jacoby population program of the university of colorado at boulder. This article provides a complete guide to general theories of consumption function. Government consumption expenditures and the current account. Keynesian keynes and his followersdo not deny this fact that even before reaching full employment production. We develop a keynesian model of aggregate consumption. The basic idea is that aggregate demand will adjust to supply, and that value theory and distribution. All the consumer behavioural theories are based on the basic law of consumption i. According to this hypothesis, consumption depends on the current level of disposable income. Permanent income, current income, and consumption john y. A theory of consumption faculty of social sciences.
This rational optimization assumption is untestable, however, without. It is shown that particular importance attaches to how net debtor households service their debts, and that the treatment of debtservicing commitments as a substitute for savings by these households. Aggregate consumption is equal to autonomous consumption plus the marginal propensity to consume times aggregate income, which is the same thing as gdp, times aggregate income minus taxes. Income seasonality and rainfall in rural india hanan g. Thus, the analysis of a change in taxes is altered drastically by making money demand dependent. In their studies of consumption, economists generally draw upon a common theoretical framework by assuming that consumers base their expenditures on a rational and informed assessment of their current and future economic circumstances. Campbell woodrow wilson school, princeton university, princeton, nj 08544 n. Explaining keynes theory of consumption, and assessing its strengths and weaknesses. This theory also argues that consumption is directly but not proportionately related to the current level of aggregate disposable income. The theory of consumer behaviour has two aspects, expenditure aspect and aggregate aspect. Ricerclw economiche 1994 48,257277 theories of savings and economic growth giuseppe bertola universitci di lbrino, cepr and nber. Marginal propensity to consume mpc the amount consumed out of an additional dollar of income.
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