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What did Keynes identify as the primary determinant of consumption?
What did Keynes identify as the primary determinant of consumption?
According to Keynes, how does consumption change in relation to increases in income?
According to Keynes, how does consumption change in relation to increases in income?
What is the Fundamental Psychological Law as per Keynes?
What is the Fundamental Psychological Law as per Keynes?
What is one of the assumptions underlying Keynes's consumption function?
What is one of the assumptions underlying Keynes's consumption function?
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When aggregate income increases, what happens to consumption expenditure according to Keynes?
When aggregate income increases, what happens to consumption expenditure according to Keynes?
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What happens to the increment of income in relation to consumption and saving?
What happens to the increment of income in relation to consumption and saving?
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How does Keynes view the relationship between consumption and saving as income rises?
How does Keynes view the relationship between consumption and saving as income rises?
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What economic condition does Keynes assume for his consumption function to hold true?
What economic condition does Keynes assume for his consumption function to hold true?
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The consumption function is specifically a relationship between consumption and what?
The consumption function is specifically a relationship between consumption and what?
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Which statement is not a proposition of the Psychological Law?
Which statement is not a proposition of the Psychological Law?
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Which of the following is not a requisite for the Psychological Law to hold?
Which of the following is not a requisite for the Psychological Law to hold?
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What equation represents the consumption function?
What equation represents the consumption function?
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Keynes analyzed the consumption-income relationship using which of the following concepts?
Keynes analyzed the consumption-income relationship using which of the following concepts?
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Which statement best describes the consumption function's dependency on income?
Which statement best describes the consumption function's dependency on income?
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In the context of consumption, what does the term 'propensity to consume' refer to?
In the context of consumption, what does the term 'propensity to consume' refer to?
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Which of the following is least likely to affect the consumption function?
Which of the following is least likely to affect the consumption function?
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What happens to household consumption expenditure as income increases?
What happens to household consumption expenditure as income increases?
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What does dissaving refer to in the context of households with low income?
What does dissaving refer to in the context of households with low income?
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What is the relationship between saving and income referred to as?
What is the relationship between saving and income referred to as?
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According to the linear equation Y = C + S, what does 'Y' represent?
According to the linear equation Y = C + S, what does 'Y' represent?
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In the consumption function equation C = a + b.Y, what does 'b' signify?
In the consumption function equation C = a + b.Y, what does 'b' signify?
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What can be said about saving when income levels rise according to the content provided?
What can be said about saving when income levels rise according to the content provided?
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At lower income levels, how do households tend to manage their consumption?
At lower income levels, how do households tend to manage their consumption?
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What generally motivates households to prioritize consumption over saving at low income levels?
What generally motivates households to prioritize consumption over saving at low income levels?
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What does the consumption function primarily refer to?
What does the consumption function primarily refer to?
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What is the main determinant of consumption according to the consumption function?
What is the main determinant of consumption according to the consumption function?
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Which hypothesis suggests that consumption behavior changes with relative income?
Which hypothesis suggests that consumption behavior changes with relative income?
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According to Engel's laws, as income increases, how do households generally adjust their spending on food?
According to Engel's laws, as income increases, how do households generally adjust their spending on food?
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Which of the following is NOT a generalization of Engel's laws?
Which of the following is NOT a generalization of Engel's laws?
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Who formulated the laws of consumption expenditure in 1857?
Who formulated the laws of consumption expenditure in 1857?
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What does the term 'propensity to consume' describe?
What does the term 'propensity to consume' describe?
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Which of the following factors does NOT influence the propensity to consume?
Which of the following factors does NOT influence the propensity to consume?
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At what income level does the society begin to make positive savings?
At what income level does the society begin to make positive savings?
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What does the 45º line in the diagram represent?
What does the 45º line in the diagram represent?
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What is the Marginal Propensity to Consume (MPC) at an income level of 250?
What is the Marginal Propensity to Consume (MPC) at an income level of 250?
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What is the level of consumption at an income level of 450?
What is the level of consumption at an income level of 450?
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What happens to planned saving when consumption exceeds income?
What happens to planned saving when consumption exceeds income?
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At which income level does the society show the highest saving?
At which income level does the society show the highest saving?
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What does the column labeled 'S' represent in Table 5.1?
What does the column labeled 'S' represent in Table 5.1?
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What does a negative value for savings indicate at an income level of 100?
What does a negative value for savings indicate at an income level of 100?
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Study Notes
Consumption Function
- The consumption function is the relationship between consumption and income
- Keynes believed that consumption mainly depends on income
- Keynes argued that as income increases, consumption increases by a smaller amount
- Keynes referred to "disposable income of the consumer"
- Keynes called this phenomenon, the "Fundamental Psychological Law"
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Keynes' Three Propositions:
- Consumption expenditure increases, but by a smaller amount, as aggregate income increases
- Income increments are divided between consumption and saving, according to a specific proportion
- Both consumption and saving increase when income increases
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Assumptions of the Law
- People's spending habits (propensity to consume) remain unchanged
- Only income changes, other factors (income distribution, price movement, population growth) remain constant
- There is a normal functioning capitalistic laissez-faire economy
- The law might not hold true in economies where the state interferes with consumption or production
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Explanation of the Law:
- Income is the most important determinant of consumption
- This relationship between income and consumption is known as the "consumption function" or "propensity to consume"
- The equation C = f(Y) represents this relationship, where:
- C is consumption
- f is function
- Y is income
Propensity to Consume
- Keynes used four concepts to analyze the consumption-income relationship:
- Average Propensity to Consume (APC): The ratio of total consumption to total income
- Marginal Propensity to Consume (MPC): The change in consumption resulting from a change in income
- Average Propensity to Save (APS): The ratio of total savings to total income
- Marginal Propensity to Save (MPS): The change in savings resulting from a change in income
- When income increases, households generally increase consumption expenditure, but less than proportionally.
- Conversely, when income decreases, households reduce consumption, but by a smaller amount.
- At lower income levels, households may have to use their past savings or borrow to keep their consumption expenditure above their income (this is called negative saving or dissaving)
- As income rises, savings tend to rise more than proportionally because basic consumption needs are met.
- The relationship between savings and income is called the "propensity to save" or "saving function."
- Disposable income (Y) is divided into consumption (C) and savings (S), expressed as: Y = C + S
- The income-consumption relationship can be expressed in a linear equation: C = a + b.Y (where a>0, 0 < b < 1)
Absolute Income Hypothesis
- This hypothesis suggests that consumption is a function of current disposable income.
- It assumes that people spend a greater proportion of their income as they earn more, but only up to a given limit.
Relative Income Hypothesis
- This hypothesis suggests that consumption is influenced by relative income, or the income of individuals compared to the income of others.
- It highlights the social comparison aspect of consumption, where people are influenced by the spending patterns of others.
Factors Determining the Propensity to Consume
- Income Distribution: The more evenly distributed income is, the higher the propensity to consume, and vice versa.
- Wealth: Individuals with more wealth tend to consume a smaller proportion of their income than those with less wealth.
- Rate of Interest: Higher interest rates make saving more attractive, leading to lower consumption.
- Consumer Confidence: High consumer confidence leads to increased consumption, while low confidence leads to decreased consumption.
- Disposable Income: The level of disposable income is a significant factor in determining consumption.
- Tax Rates: Higher taxes reduce disposable income, leading to lower consumption.
- Inflation: High inflation erodes purchasing power, making consumers more likely to save and less likely to spend.
- Availability of Credit: Easy access to credit can encourage higher consumption, while tight credit can stifle spending.
- Expected Prices: Consumers may delay purchases if they expect prices to fall in the future.
- Government Policies: Government policies such as subsidies, tax breaks, and social welfare programs can also influence consumption patterns.
- Population Growth: Population growth can lead to higher consumption as more people demand goods and services.
- Technological Advancements: New technology can lead to increased consumer spending on new products and services.
- Social and Cultural Factors: Social and cultural factors play a role in shaping consumption patterns, such as spending on luxury goods or services influenced by norms and trends.
- Demographic Factors: Age, household size, marital status, and education level all influence consumption patterns.
- Psychological factors: Consumer confidence and expectations about future economic conditions.
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Description
Explore the Consumption Function and its significance in Keynesian economics. This quiz covers Keynes' belief that consumption depends on income levels and his three key propositions. Test your understanding of the relationship between consumption, saving, and disposable income.
