Even before the publication of Johan Maynard Keynes book, some economists were of the view that income and consumption were functionally related. However, it was Keynes who first stressed the importance of the positive functional relationship between aggregate income and aggregate consumption. The consumption function c = f(y) suggested by Keynes is a theoretical one since it is not based on empirical information on income and consumption. The theoretical consumption functions, as explained by Keynes. It has the following properties.
1. Autonomous Consumption is Positive (Ca)
Ca is the positive y-intercept of the consumption function, which shows that consumption spending is positive even, when income is zero.
To realize consumption of zero income, people either utilize their past saving, borrow or both, which means negative savings.
2. Marginal Propensity to Consume (MPC)
Δc/Δy = dc / dy = slope of the consumption function = the rate of change of consumption with respect to a change in income. In economics, this is called, the marginal propensity to consume (MPC). The Marginal Propensity to Consume (PMC) has the following properties.
- Marginal Propensity to Consume (PMC) remains constant through out length of the consumption function.
- Marginal Propensity to Consume (PMC) is always positive
- Marginal Propensity to Consume (PMC) lies within the range of zero
3. Average Propensity to Consume
The average propensity to consume APC = c/y falls with every increase in the level of income. This means that the relationship between income and consumption is non-proportional. In other words, as income rises, a lower fraction of income is devoted to saving. It is due to the fact that the urgent needs of the consumers get satisfied as their income rises. In short, according to Keynes, as income rises average propensity to consume falls and Average Propensity to Saving rises, but APC = APS = 1, for all levels of income.
After the appearance of “The General Theory” economists worked on the Keynes consumption function and tested it against empirical data. They employed sophisticated mathematical and statistical tools to verify the theoretical income consumption model suggested by Keynes and thus the economists, after Keynes, formulated new theories of consumption, demand, which are collectively new “theories of consumption demand”. The most important among them are
The relative income theory
The permanent income theory
The life cycle theory of consumption demand
It is interesting to note that each of these theories assign a different role to income that is the meaning of income is different in all these theories of consumption demand.