In economics, the consumption function describes a relationship between consumption and disposable income. The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a government spending multiplier.
Its simplest form is the linear consumption function used frequently in simple Keynesian models:
where is the autonomous consumption that is independent of disposable income; in other words, consumption when income is zero. The term is the induced consumption that is influenced by the economy's income level . The parameter is known as the marginal propensity to consume, i.e. the increase in consumption due to an incremental increase in disposable income, since . Geometrically, is the slope of the consumption function. One of the key assumptions of Keynesian economics is that this parameter is positive but smaller than one, i.e. .
Keynes also took note of the tendency for the marginal propensity to consume to decrease as income increases, i.e. . If this assumption is to be used, it would result in a nonlinear consumption function with a diminishing slope. Further theories on the shape of the consumption function include James Duesenberry's (1949) relative consumption expenditure, Franco Modigliani and Richard Brumberg's (1954) life-cycle hypothesis, and Milton Friedman's (1957) permanent income hypothesis.
Some new theoretical works following Duesenberry's and based in behavioral economics suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviorally-based aggregate consumption function.
- Aggregate demand
- Absolute income hypothesis
- Life cycle hypothesis
- Measures of national income and output
- Permanent income hypothesis
- Algebraically, this means where is a function that maps levels of disposable income —income after government intervention, such as taxes or transfer payments—into levels of consumption .
- Lindauer, John (1976). Macroeconomics (Third ed.). New York: John Wiley & Sons. pp. 40–43. ISBN 0-471-53572-9.
- Hall, Robert E.; Taylor, John B. (1986). "Consumption and Income". Macroeconomics: Theory, Performance, and Policy. New York: W. W. Norton. pp. 63–67. ISBN 0-393-95398-X.
- Colander, David (1986). Macroeconomics: Theory and Policy. Glenview: Scott, Foresman and Co. pp. 94–97. ISBN 0-673-16648-1.
- Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich. p. 96.
The fundamental psychological law ... is that men [and women] are disposed, as a rule and on average, to increase their consumption as their income increases, but not as much as the increase in their income.
- Keynes, John M. (1936). The General Theory of Employment, Interest and Money. New York: Harcourt Brace Jovanovich.
The marginal propensity to consume is not constant for all levels of employment, and it is probable that there will be, as a rule, a tendency for it to diminish as employment increases; when real income increases, that is to say, the community will wish to consume a gradually diminishing proportion of it.
- Duesenberry, J. S. (1949). Income, Saving and the Theory of Consumer Behavior.
- Friedman, M. (1957). A Theory of the Consumption Function.
- d’Orlando, F.; Sanfilippo, E. (2010). "Behavioral foundations for the Keynesian consumption function" (PDF). Journal of Economic Psychology. 31 (6): 1035. doi:10.1016/j.joep.2010.09.004.
- Poindexter, J. Carl (1976). "The Consumption Function". Macroeconomics. Hinsdale: Dryden Press. pp. 113–141. ISBN 0-03-089419-0. (Undergraduate level discussion of the subject.)
- Sargent, Thomas J. (1979). "The Consumption Function". Macroeconomic Theory. New York: Academic Press. pp. 298–323. ISBN 0-12-619750-4. (Graduate level discussion of the subject.)