KEYNE'S PSYCHOLOGICAL LAW OF CONSUMPTION /MACRO ECONOMICS//B.A.//M.A.//11TH CLASS//12TH CLASS
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Psychological Law of Consumption: (Assumptions and Implication)
The Keynesian concept of consumption function stems from the fundamental psychological law
of consumption which states that there is a common tendency for people to spend more on
consumption when income increases, but not to the same extent as the rise in income because a
part of the income is also saved. The community, as a rule, consumes as well as saves a larger
amount with a rise in income.
Thus, Keynes’ psychological law of consumption is based on the following propositions:
i. When the total income of a community increases, the consumption expenditure of the
community will also increase, but less proportionately.
ii. It follows from this that an increase in income is always bifurcated into spending and saving.
iii. An increase in income will, thus, lead to an increase in both consumption and savings. This
means that with an increase in income in the community, we cannot normally expect a
reduction in total consumption or a reduction in total savings. A rising income will often be
accompanied by increased savings and a falling income by decreased savings. The rate of
increase or decrease in savings will be greater in the initial stages of increase or decrease of
income than in the later stages.
The gist of Keynes‟ law is that consumption mainly depends on income and that income
recipients always do not tend to spend all of the increased income on consumption. This is the
fundamental maxim upon which Keynes‟ concept of consumption function is based.
Implications of the Psychological Law of Consumption:
A more detailed analysis of Keynes‟ law shows that it has the following important implications:
1. Highlighting the crucial importance of investment in an economy:
A vital point in the law is the tendency of people not to spend on consumption the full amount of
an increase in their income. There is thus a “gap” between aggregate income and aggregate
consumption.
Assuming the consumption function to be stable during a short-run period, the “gap” will widen
with an increase in income. This gives rise to the problem of investment. Investment should be
increased to fill the gap between income and consumption. Keynes, therefore, stresses that
investment is the crucial and initiating determinant of levels of income and employment.
2. Refuting Say’s Law:
It refutes Say‟s Law of market by indicating the demand deficiency and possibility of overproduction.
3. Explanation to the Business Cycle:
An explanation of the turning points of a business cycle is also provided by this law. The upper
turning point from a boom is caused by a collapse of the marginal efficiency of capital owing to
the fact that consumption expenditure does not keep pace with increase in income during the
prosperity phase.
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