8 essential factors that determines propensity to consume

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Objective factors

(1) Income:-

Income is the most important factor which determines the consumption expenditure in a society. The greater the level of disposable income, the higher is the consumption expenditure with a fall in income, the consumption demand of household goes down.

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(2) Distribution of income:

Consumption function depends on the way in which the income is distributed. Greater the inequality-in income distribution, lower will be the propensity to consume, greater the equality in income distribution, higher will be the propensity to consume. An equal distribution of income will raise consumption function because the poor people will increase their consumption expenditure more than the expenditure of the rich.

(3) Wage level:

If the wage rate arises, the consumption function shifts upward. If the rise in price level is more in proportionate to the rise in wage, the real wage will fall and consumption function will shift downward.

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(4) Rate of interest:

A significant rise in interest rate will induce people to consume less and save more in order to gain from the higher rate interest. On the contrary, an increase in tin- interest rate may diminish investment and reduce income. Will the fall in income saving falls even at a higher rate of interest.

(5) Holding of liquid assets:

The consumption function also influenced by the holding of liquid assets, (Govt, bond, cash) When people have more liquid assets, they will spend more out of their current income and that their propensity to consume will increase. An increase in the real value of there assets will raise consumption expenditure.

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(6) Changes in expectation:

Changes in future expectation also affect the consumption function. Expectation of emergency and fear of shortage of essential goods will induce people to purchase the goods much in excess of their current needs. This will shift the consumption upward.

(7) Wind fall gains and losses:

Windfall gains tend to arise the propensity to consume while widespread losses will shift the consumption function downward.

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(8) Fiscal policy:

Heavy indirect taxation, rationing and price control adversely affect the propensity to consume. Progressive tax shifts the consumption function upward by bringing about more equitable distribution of income.

Subjective factors:

Subjective factors are indigenous or internal to economic system subjective factors determine the form of consumption function.

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(i) People save to face the unforeseen contingencies such as Illness, unemployed, accidents etc.

(ii) People are induced to save because they want to provide for the future needs, i.e. education of the children, marriages of the children etc.

(iii) To possess power or to get higher social or political status.

(iv) People are motivated to save so that they can accumulate large wealth which will increase their social states.

(v) To enjoy an enlarged future income by investing funds of current income.

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