Nta UGC-NET dec-2018

Online batch ,Lecture-17

Macro eco Topic- 2

Consumption function
&
Keynesian theory of
emloyment
UGC-NET PAPER-2 (ECO)
CONSUMPTION FUNCTION
 Propensities

Propensity to Propensity to
consume save

APC MPC
APS MPS
 Propensity to consume

APC MPC

APC is the ratio bw consumption MPC is the ratio bw change in

and income.
consumption and change in
income.
APC = C/Y
MPC = ΔC/ Δ Y
Consumption is positively related
with income.
MPC is constant at all level of
As income increases APC falliing. income.
 APC

In situation -1 ( APC>1)

In situation -2 ( APC=1)
In situation -3 ( APC<1)
MPC
 Propensity to save

APS MPS

APS is the ratio bw Saving and income. MPC is the ratio bw change in saving
and change in income.
APS = S/Y
MPS = ΔS/ Δ Y
APS = 1-APC

saving is positively related with income. MPS = 1-MPC

MPS is constant at all level of income.

As income increases APS Increasing.
 APS

In situation -1 ( APS is negative)

In situation -2 ( APS=0)
In situation -3 ( APC<1)
MPS
Keynesian theory of
emloyment
Intro-
As per Keynes theory of employment, effective demand signifies the money spent
on the consumption of goods and services and on investment.

The total expenditure is equal to the national income, which is equivalent to the
national output.

Therefore, effective demand is equal to total expenditure as well as national income

and national output.

The Keynes theory of employment was based on the view of the short run.

according to Keynes, level of employment is dependent on national income and

output.

Keynes advocated that if there is an increase in national income, there would be

an increase in level of employment and vice versa

Therefore, Keynes theory of employment is also known as theory of employment

determination and theory of income determination.
 Principle of Effective Demand:

Keynes borrow concept of effective demand from Malthus.

Keynes has used two key terms, namely, aggregate demand price and aggregate
supply price, for determining effective demand.

which further helps in estimating the level of employment of an economy at a

particular period of time.

The level of employment can be determined with the help of aggregate supply price
and aggregate demand price

The effective demand can be expressed as follows:

Effective demand = National Income = National Output

Therefore effective demand affects employment level of a country, national income,

and national output.
This theory applicable in capitalist economy.

Effective demand means total demand for goods and services at

various level of employment.

Different level of employment represent different level of ED.

At the level where AD and AS equal to each other called ED.

ACC. To Keynes level of employment determined by ED.

 [Link] Supply Price:

In simpler words, aggregate supply price is the cost of production of

products and services at a particular level of employment.

It is the total amount of money paid by organizations to the different

factors of production involved in the production of output.

Thus, the slope of aggregate supply price curve would be upward to

the right.
 Aggregate Demand Price:

Aggregate demand price is the total amount of money that an

organization expects to receive from the sale of output produced by a
specific number of workers.

On the hand, In other words, the aggregate demand price

signifies the expected sale receipts received by the
organization by employing a specific number of workers.

Consequently, the increase in the employment level would increase

the aggregate demand price.

Thus, the slope of aggregate demand curve would be upward to the

right.

However, the individual demand curve slopes downward.

 Determination of Equilibrium Level of Employment:

The aggregate demand (AD) and aggregate supply (AS) curve are
used for determining the equilibrium level of employment,
AD represents the aggregate demand curve

AS represents the aggregate supply curve

aggregate demand and aggregate supply

curve are moving in the same direction,

but they are not alike.

There are different aggregate demand
price and aggregate supply price for
different levels of employment.
at AS curve, the organization would
employ ON1 number of workers, when
they receive OC amount of sales
receipts.
 in case of AD curve, the organization would
employ ON1 number of workers with the
expectation that they would produce OH
amount of sales receipt for them.

at ON1 employment level, the aggregate

demand price (OH) is greater than the
aggregate supply price (OC).

At certain level of employment, the

aggregate demand price and aggregate
supply price become equal.

the aggregate demand price (OH) is

greater than the aggregate supply price
(OC).
However, at certain level of employment,
the aggregate demand price and
aggregate supply price become equal.
After eqm (ED), price would be constant and
AD curve become horizontal.

When the economy reaches at full

employment the AS curve become vertical.

After full employment increase in aggregate

supply price would not provide more
employment.

Acc. To keynes when general prices

increases then employment also increases.
According to Keynes employment determined also by entrepreneurs
expect to receive equal to must receive.

In ED situation entrepreneur earn normal profit.

If AD price > AS price. Entrepreneur get profit and employed more
worker.
If AS prices > AD prices then cost increases – entrepreneur get losses
and employ less workers.

Price relate positively with employment.

equilibrium can be achieved when the amount of sales receipt

necessary and the amount of sales receipt expected to be received
by the organization at a specified level of employment are equal.
 Keynesian
Consumption function
Intro-

The consumption function states that aggregate real consumption

expenditure of an economy is a function of real national income.

This is called the Keynesian Consumption Function.

The classical economists used to argue that consumption was a

function of the rate of interest such that as the rate of interest
increased the consumption expenditure decreased and vice versa.

Keynes stated that the rate of interest may have some influence on
consumption but the real income was the important determinant of
consumption.
the aggregate consumption function states that real consumption is a
function of real income

consumption function can be written as C = C(Y)

where C is real consumption expenditure and Y is real national

income.

This is the Keynesian Consumption Function.

The straight line consumption function has a constant slope at

all points.

The (APC) Average propensity to consume decreases as income

increases.
 According to Keynes the consumption function must possess the following
characteristics:

(1) Aggregate real consumption expenditure is a stable function of real income.

(2) The marginal propensity to consume (MPC) or the slope of the consumption
function defined as dc/dY must lie between zero and one i.e. 0 < MPC < 1.

(3) The average propensity to consume (APC) or the proportion of income spent on
consumption defined as C/Y should be decreasing as income increases.

when average falls, marginal is below average.

Thus, when the average propensity to consume (APC) falls, the marginal propensity
to consume (MPC) must be lower than the APC.

(4) The marginal propensity to consume (MPC) itself probably decreases or remains
constant as income increases.
 Propensity to consume.

Marginal
Average
Propensity
Propensity
to
to
Consume:
Consume:

MPC calculated by
APC calculated by dividing the amount
dividing the of change in
amount of consumption by the
consumption by change in total
the total income. income.
APC = C/Y MPC = ΔC/ΔY
 As income increases APC
decreases.
Income increases more than
consumption.

MPC would remain constant at all

level of income.

In the short run APC>MPC

In the long run APC=MPC

Keynes is concern with primarily

with the MPC for analysis short
terms.

And APC is useful for long run

analysis.
Acc. To Keynes MPC is more prominence.
In Keynesian analysis MPC and MPS are always constant.

MPC filling the gap bw income and consumption through planned

investment to maintain the level of income.

In the long run propensity to consume does not fall with increase
in income.(MPC constant in long run.)
 1. Short run consumption function.

In short run APC>MPC.

In short run consumption function is linear and non-proportion.

In short run consumption curve not start with origin.

Short run consumption function written as

C=a+bY

Short run is constitute with – autonomous

consumption + MPC.( C= a+By)
 [Link] run consumption function.

In short run APC=MPC.

In long run consumption function is linear and proportion.

In long run consumption curve start with origin.

Long run consumption function written as

C=bY

long run is constitute with only MPC.( C= bY)

 Keynesian
psychological law of
consumption.
 Keynes’s Psychological Law of Consumption:

Keynes put forward a psychological law of consumption, according to

which, as income increases consumption increases but not by as
much as the increase in income.

In other words, marginal propensity to consume is less than one.

1 > ∆C/∆Y > 0

Keynes recognized that many subjective and objective factors

including interest rate and wealth influenced the level of consumption
expenditure,

He emphasized that it is the current level of income on which the

consumption spending of an individual and the society depends.
Acc to him, “The amount of aggregate consumption depends mainly
on the amount of aggregate income.

This law has three proposition

1. When income increases, consumption expenditure also increases

but less than proportionately.

2. Increase in income will provide into same proportion bw saving

and consumption.

3. Increase in income will lead to increase in both consumption and

saving.
In the long run with increase in income , propensity to consume is not
decrease, it is remain constant.

he suggests that consumption expenditure depends mainly on

absolute income of the current period, that is, consumption is a
positive function of the absolute level of current income.

Keynes points out that consumption expenditure does not have a

proportional relationship with income.

Keynes argues that average propensity to consume (APC) falls as

income increases.
The Keynes’ consumption function can be expressed
in the following form:

C = a + bYd

where C is consumption expenditure and

Yd is the real disposable income which equals gross national income minus taxes,

a and b are constants, where a is the intercept term,

Thus, a is autonomous consumption.

The parameter b is the marginal propensity to consume (MPC)

 MPC = ∆C/∆Y

During short period- MPC < APC

This is because as income rises consumption does not increase

proportionately
as income falls consumption does not fall proportionately as people
seek to protect their earlier consumption standards.

The assumption of diminishing average propensity to consume is a

significant part of Keynesian theory of income and employment.

This implies that as income increases, a progressively larger

proportion of national income would be saved.
On the basis of this increasing proportion of saving with the increase
in income and, consequently, the emergence of the problem of
demand deficiency,

some Keynesian economists based the theory of secular stagnation

on the declining propensity to consume.

In the long run increased in saving and decrease in investment called

secular stagnation.
Mcq’s
Q1. if income level increases then APS

A. increases.
B. Decreases.
C. Constant.
D. None.

Q2. with increase in income in long run , the MPS would be

A. increases.
B. Decreases.
C. Constant.
D. None.
Q3. in long run keynesian consumption function written as

A. C= a + bY
B. C= bY
C. C= C(Y)
D. C= b+cY

Q4. Keynesian long run consumption function is

A. Linear and non-proportion.

B. Non linear and non-proportion.
C. Linear and proportion.
D. All of the above.
Q5. In the long run increased in saving and decrease in investment
called

A. Inflation.
B. Deflation.
C. Secular inflation.
D. Secular deflation.
 Ans keys

1. A
2. C
3. B
4. C
5. C
Nta UGC-NET dec-2018
Online batch ,Lecture-18
Macro eco Topic- 3

concept of multiplier and

accelerator.

UGC-NET PAPER-2 (ECO)