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Questions and Answers
What is consumption?
The act of spending income for buying goods and services to satisfy wants.
What is the consumption function?
A relation between consumption and its various determinants.
Which of the following is NOT a determinant of consumption?
What does MPC stand for?
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According to Keynes, what is the most important determinant of consumption?
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What does the equation $C=f(Ya)$ represent?
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Marginal propensity to consume (MPC) is always equal to 1.
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According to Keynes, the psychological law of consumption states that consumption increases as income increases, but not by as much as the increase in income. This is described by the __________.
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Study Notes
Keynesian Consumption Function
- Keynesian consumption function assumes consumption is primarily influenced by income.
- Higher income leads to higher consumption.
- Keynes' "psychological law of consumption" states that while increased income leads to increased consumption, the increase in consumption is less than the increase in income.
Consumption and Investment
- The text focuses on a two-sector model, which simplifies the economy by ignoring government and foreign trade.
- Total output (Y₁) equals consumption (C) plus savings (S), or aggregate demand(AD).
- In this model, consumption plus savings equals consumption plus investment (C+S=C+I).
Consumption
- Consumption is the act of spending income on goods and services to satisfy wants.
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Determinants of consumption:
- Disposable income (after-tax income)
- Accumulated wealth or assets
- Expected future income
- Actual price level
- Expected general price level
- Rate of interest
- Personal thriftiness
- Age, sex, and family size
Consumption Function
- The consumption function represents the relationship between consumption and its determinants.
- A general consumption function can be written as: C=f(Ya, W, Ye, P, Pe, r, s, DF.....)
- Ya = Disposable income
- W = Wealth
- Ye = Expected future income
- P = Actual price level
- Pe = Expected general price level
- r = Rate of interest
- s = Thriftiness
- DF = Other factors
Keynesian Consumption Function
- Keynes argues that disposable income is the most important determinant of consumption.
- The Keynesian consumption function is represented as: C=f(Ya), 1>f>0
- C = Consumption demand
- Ya = Disposable income = (Y-T)
- Y = Personal income
- T = Taxes related to income
Keynesian Psychological Law
- Keynes' "fundamental psychological law" suggests that individuals increase their consumption with increased income, but not by the same amount.
- This implies that the marginal propensity to consume (MPC) is positive but less than one (0<MPC<1).
- MPC is the change in consumption due to a change in disposable income.
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Description
This quiz explores the Keynesian consumption function, which emphasizes the relationship between income and consumption. It discusses how higher income impacts consumption and the basic elements of the two-sector model of consumption and investment. Test your understanding of the determinants of consumption and the implications of these economic theories.
