Determinants of Consumption Function
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Management Notes | Pokhara University
The factors that affect the demand for consumption are called determinants of consumption function.J.M Keynes has divided factors influencing the consumption function into two parts: Subjective factors (They are the internal factors influencing the consumption function) and Objective factors ( They are the external factors influencing the consumption function).
A) Subjective Factors:
Subjective factors are the internal factors or we can say factors related to psychological feelings influencing the consumption function.Major subjective factors influencing consumption function are:
Securitive motive plays an important role in determining the consumption function. As we know there are many provision of social security program like old age allowances,unemployment allowances ,disable allowances which helps to increase the consumption expenditure or simply consumption function.If there is insecurity ,people may hold certain amount of money which reduces consumption expenditure.
2) Demonstration Effects:
Demonstration Effects plays an important role in determining the consumption function. Many people are influenced by the consumption of other people and try to adopt similar consumption practice which is called demonstration effect. This effect increases the consumption expenditure.
3)Increasing Social Status:
Social Status plays an important role in determining the consumption function. People are more motivated to save more and accumulate large wealth with a believe that it will increase their social status. This helps to increase saving and decrease the consumption of the people.
Business firm desire to save more to increase undistributed corporate profit for the expansion and modernization of business. If the business firm keeps realtively larger amount of its profit for financial prudence development and pay smaller amount of profit as dividends to the shareholder , which will automatically reduce the propensity to consume of the society.
B) Objective Factors:
Objective factors are the external factors or we can say factors which are real and are measurable influencing the consumption function. These factors can be easily changed in the long run.Major subjective factors influencing consumption function are:
1)Income of the people:
Income plays an important role in determining the consumption function.Income of the people is the most influencing factor for consumption and there is positive relationship between income and consumption. When income increases, consumption also increases and vice-versa.
Income Distribution plays an important role in determining the consumption function.If there is large disparity between rich and poor ,the consumption is low because the rich people have low propensity to consume than the poor people .Similarly ,a community with a very equal distribution of income tends to have high propensity to consume and low propensity to save.
Price level plays an important role in determining the consumption function.When the price falls, people will consume more and propensity to consume of the society increases.
Wages level plays an important role in determining the consumption function.When wages increases ,people will consume more and vice-versa.
Rate of interest plays an important role in determining the consumption function.Higher the rate of interest will lead people to save money more and reduces consumption.
Fiscal policy plays an important role in determining the consumption functionWhen government reduces the tax,the propensity to consume of community increases. The progressive tax system increases the propensity to consume of the people by altering the income distribution.