Consumption function or propensity to consume represents functional relationship between two aggregate i.e. total Consumption and total income. It indicates how consumption expenditure.
Varies with given changes in income. Propensity to consume to be distinguished from consumption. Consumption means expenditure and consumer goods at a given level of income, while propensity to consume refers to the schedule showing consumption expenditure at various levels of income. Thus consumption is a notion of income. This can be stated symbolically as C=f(y).
According to the psychological law of consumption, people have a tendency to spend more unconsumption when their income increases, but not to the extent by which the income rises. A pail of income is saved. In other words people increase both consumption and saving with the rise in income.
The psychological law of consumption has three important propositions, (i) When aggregate income increases aggregate consumption also increases but by smaller amount (ii) The increase in income is distributed in some ratio between saving and consumption (iii) Both saving and consumption will increase at a result of the increase in income, these three proposition can be explained with the help of following table.
Consumption function is 14 drawn according to the above schedule.
(a) The 45° (y=c) line indicates that at all the points on this line the whole income is spent and nothing is saved.
(b) The ABC Line represents consumption function. It is derived on the basis of psychological law of consumption, expresses that as income increases consumption also increase but not in the same proportion.
(c) The consumption function starts from point A on the OY- axis but not from the origin ‘O’. This means when income falls to zero, consumption does not fall to zero. The positive consumption zero income level is autonomous consumption which is dependent of income.
(d) When income is less than consumption (less than OY level of income), the gap is covered by disserving. AOB represents saving.
(e) At OY income level consumption is equal to income and there is neither saving nor disserving, when income is more than assumption i.e. more than OY level of income, the gap between 450 line and consumption function constitutes saving.
Given the subjective factors consumption demand depends level of income(Y) price level (P), income distribution (D), rate interest (i) etc. consumption function can be written as:
Consumption expenditure along Oy-axis. Consumption function expressed in terms of an equilibrium c=a+b where a is the constant and b is the slope of the consumption fraction C. The assumption function relates the amount of consumption to the income. Thus it is clear that consumption function or the propensity to consume is the whole schedule which describes the amount of consumption at various level of income.
When propensity to consume of a community changes, the whole propensity to consume curve shifts. When propensity to consume increase, it implies that consumption is more at several of income. Thus with the increase in propensity to consume, whole propensity to consume curve shifts upward.
When propensity to consume of the community decreases, the whole propensity to consume curve shifts downward expressing that at us levels of income less is consumed than before. The consumption function Cc shifts upward to the position C’C1 signify that consumption rises at every level of income.