What are the factors that determine the consumption function in economics?

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(i) Keynes does not base current consumption on income of the preceding period (or periods). In his theory, it depends upon the expected income in the forthcoming period. Moreover, in his theory, consumption does not necessarily come out of even expected income. It may be financed by spending past saving or by borrowing.

(ii) The classical economists assumed that saving by income earners was a direct function of the level of interest rate, Income, whether realized or expected, played no part in the saving decisions of the income earners. Logically, therefore, it was possible to increase i to a level at which the income earners would be ready to save their entire income and reduce their consumption to zero.

In contrast, Keynes maintained that saving (and therefore, consumption) was totally interest inelastic. People saved not to earn interest on their saving, but for purposes like providing against old age, periods of low income and so on. Having saved on these considerations, they allocated their cumulative savings (or total wealth) so as to achieve an optimum portfolio. Rate of interest played a part in the determination of asset portfolio and not in the decision of saving as such.

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Keynes further maintained that, even theoretically, consumption expenditure never falls to zero. In order to live and be a member of the society, some minimum consumption is necessary. In other words, Keynes rejects both extreme possibilities of the classical theory.

(iii) While relating consumption to income, Keynes held that people were accustomed to their prevalent consumption standards. As a result, in the short run change in consumption was always less than that in income. Therefore, in Keynesian theory, MFC is always less than one. And for similar reasons, it also tends to fall with an increase in income.

(iv) A number of other factors also influence the consumption function. They include the attitude of income earners towards thrift, their views regarding holding of liquid assets, and so on. For example, a thrifty community is expected to have a lower ARC. In addition, this function is also affected by several institutional and legal factors like the existence or absence of a social security system. Expectations regarding inflationary behavior of prices also affects the consumption function. When prices are expected to increase, people tend to consume more and vice versa.

(v) Consumption of the community is also affected by the distribution of income and wealth. It is commonly believed that people with low income and less wealth have higher ARC and MFC.

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(vi) Keynes assumes that the consumption function of the community is a stable one in the short run. His stand is based on three assumptions.

(a) The existing psychological factors like social norms remain unchanged.

(b) The community is not facing abnormal conditions like those of war, hyperinflation, political revolution, and the like.

(c) The economy is a well-developed one and the government follows, more or less, a policy of non-intervention. Market forces are given maximum freedom to operate.

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