Federal Urdu University Islamabad

Faculty of Management Sciences

(Department of Business Administration)
Lecture # 04
Course Title: ‘ Macro Economics’
Course Instructor: Ms. Maryam Bibi
BBA 3rd semester
Keynes Psychological Law of Consumption
• Keynes Psychological Law of Consumption states that the more
income people have, the more they will consume.
• Keynes introduced the marginal propensity to consume, the
amount consumed out of an additional dollar of income is
between zero and one. According to fundamental law out of
every dollar of earned income, people will consume part of it and
save the rest.
• Keynes also proposed the average propensity to consume, the
ratio of consumption to income which falls as income rises.
• Keynes also held that income is the primary determinant of
consumption and that the interest rate does not have an
important role.
 Consumption Function
C =f (Y)
• This consumption function shows that if income
increases consumption also increases i.e
dc/dy > 0
• Furthermore increase in consumption is less
than increase in income i.e,
dc/dy < 1
Hence value of consumption lies between 1and 0
0< dc/dy < 1
This is called Marginal Propensity to Consume,MPC
“MPC” is the change in consumption that occurs
from a small change of income.
If Y = $100 in 2019 And Consumption = 80
Y = $ 110 rises in 2020 Consumption = 88
0< dc/dy < 1
8/10=0.8
Hence MPC is less than 1
MPC= dc/dy
• Consumption cannot be equal to zero as
individuals use their past savings if they are
not currently earning.

C
C =a +by

45
0
Y
Cont;
• a = autonomous consumption
• b = MPC
• Y = income
• C= consumption
 Average Propensity to Consume (APC):

Average propensity to consume refers to the

ratio of consumption expenditure to the
corresponding level of income.
APC = Consumption (C) / Income (Y)
(i) APC is more than 1:
As long as consumption is more than national income, i.e. before the break-
even point, APC > 1.
(ii) APC = 1:
At the Break-even point, consumption is equal to national income. So, APC =
1 at the income level of Rs 200 crores.
(iii) APC is less than 1:
Beyond the break-even point, consumption is less than national income. As
a result, APC <1.
(iv) APC falls with increase in income:
APC falls continuously with increase in income because the proportion of
income spent on consumption keeps on decreasing.
(v) APC can never be zero: APC can be zero only when consumption
becomes zero. However, consumption is never zero at any level of income.
Even at zero level of national income, there is autonomous consumption (c).
Factors Influencing Consumption Function
Objective Factors
Fiscal policy: Fiscal policy of the government will also influence the
consumption behaviour of an economy.  A reduction in taxation will leave
more post-tax incomes with the people and this will stimulate higher
expenditure on consumptions.  Similarly, an increase in taxes will depress
consumption.
Changes in business expectations: Business expectations by affecting the
incomes of certain classes of people affect consumption function.
 Windfall gains and losses: The windfall losses and gains arising out of
changes in capital values affect the ‘saving brackets’ mostly and not the
spending sections.  Hence, their influence on consumption function is not so
well marked.
   Substantial changes in the rate of interest: reward on savings encourage
consumption
 Subjective Factors
(a)   Individual motives to save:
(i)      Building of reserves for unforeseen contingencies as illness or
unemployment,
(ii)    To provide for anticipated future needs such as daughter’s
wedding, son’s education, etc.
(iii)   To enjoy an enlarged future income by investing funds out of
current income, etc.
(b)   Business motives:
(i)      The desire to expand business,
(ii)    The desire to face emergencies successfully,
(iii)   The desire to have successful management,
(iv)  The desire to ensure sufficient financial provision against
depreciation or discharging of debt.