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Keynesian Model In Economics

Keynesian Model In Economics

Consumption is the spending on consumer goods over a given period, usually a year. Consumer goods are goods and services that are consumed or used up within the year, such as food or electricity. In practice, however, many goods counted as consumption goods last longer than a year such as dresses, cars and toasters, etc.

John Maynard Keynes made two key assumptions about what determines consumption spending.

  • Assumption 1: People base their consumption spending mainly on their current take-home pay, i.e., on disposable income or DI.
  • Assumption 2: When people get additional income, they do not spend it all.

Keynesian Consumption Function shows the level of consumption at different levels of disposable income, holding constant the other determinants of consumption. In Keynesian Consumption Function, consumption goes up as the disposable income goes up but not all of the additional income is consumed.

The Keynesian Consumption Function

Disposable Income (DI) Consumption (C) Savings (S)
$ 3000 $ 3400 – $ 400
4000 4200 – 200
5000 5000 0
6000 5800 200
7000 6600 400
8000 7400 600
9000 8200 800
10000 9000 1000

Savings is unconsumed income (disposable income minus consumption). At the “break-even” income of $5000, savings are zero. Below, $5000, there is dissaving (or negative savings). To dissave – to consume more than is earned – people can borrow money or draw down their bank accounts. Above $5000, savings are positive. Every $1000 added to income adds $200 to savings. The marginal propensity to save (MPS) is the added savings divided by the disposable income that caused savings to go up. Here MPS = 0.2 = ($200/$1000)

Since every added dollar of income is consumed or saved, we have:

MPC + MPS = 1

Note that the average propensity to consume (APC), which is consumption divided by disposable income, does not have to equal the MPC. At DI = $10000, for example, C/Di = 0.9 while MPC = 0.8.

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Our other articles on Economics includeLabor Economics, Inflation, Demand for Money, Balance of Payments and Balance of Payment (contd)

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