What is a consumption function?

John Maynard Keynes.

The consumption function is an attempt to mathematically express how consumer spending works. It is based on two types of spending: autonomous spending that is constant and induced spending that varies with income levels. Critics of the consumption function suggest that it does not take future income into account.

There are several ways to express the consumption function, but they all involve adding two numbers. A number is simply autonomous spending. The other figure is disposable income for consumers multiplied by the proportion of disposable income that is spent on induced spending, that is, spending is one that varies with income levels. It can include goods and services considered luxuries, but it can also include buying better quality products used for basic necessities.

Autonomous spending is spending that stays the same regardless of people’s income. In theory, this would include spending on essentials such as rent or mortgage payments, basic food and clothing. It is possible that the total autonomous expenditure is greater than the total revenue. This would happen where the economy was in a bad shape and, taken as a general average, people depended on savings or loans to finance their basic needs.

The consumption function uses a measure known as the marginal consumer propensity. This measures how much of any increase in income consumers are likely to spend. Most economists believe that this is not a constant factor, but rather a factor that decreases with income. This means that while consumer spending increases with income, it does not increase as quickly. This is because the more money people have, the more likely they are to feel that their needs are met and to be in a position to decide against additional “wasteful” spending.

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The consumption function is also known as the absolute income hypothesis. It was originally developed by economist John Maynard Keynes in the early 20th century. Modern studies consider it to be a reliable guide in the short term, but not as accurate in the long term.

There are several theories that try to correct this gap. The permanent income hypothesis takes into account that people are more likely to borrow money for “unnecessary” expenses, because they expect to fund it with future income, whether from a salary increase during their working life or windfall gains such as inheritance. The life cycle hypothesis works along similar lines and suggests that a consumer’s annual expenditures constitute a stable percentage of the total income he expects to earn over his lifetime, taking retirement into account.

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