psychological law of consumption was propounded by Keynes. therefore, this law is also known as "Keynesian psychological law of consumption". the main basis of this law propounded by Keynes is the income. assorting to this law in any capitalistic or mixed economy the increase in income of the consumers will result in the increase in consumption expenditure also. but consumption expenditure won't increase proportionately as the increase in income. thus, this is also known as propensity to consume. consumption function is also based on the psychological law of consumption there is apparently no difference between these two. however due to definite importance of this law in the macro-economic analysis this law has been presented separately to make the nature of propensity to consume clear, the psychological law of consumption was propounded by Keynes. this law is mainly based on the following three facts:
1. when income increase, the consumption expenditure will also increase, but consumption expenditure will increase less proportionately than the increase in income.
2. increase in income is divided into consumption and saving in the same ration.
3. increase in income will result in the increase in both the consumption expenditure and savings.
Keynesian theory of consumption is basically dependent upon consumption expenditure does not increase as the increase in income.
1. assumptions of psychological law of consumption
Keynesian psychological law of consumption is based on the following three assumption:
(a) no change in institutional factors
among the factors influencing the consumer, only the income will change. other institutional factors such as, desire, behaviour, fashion population, price,etc. related to psychology do not change.
(b) normal situation
for the application of this law, the normal situation should always prevail in the economy. that is unusual situations such as war, revolution, hyper-inflation, etc. should not occur in the economy.
(c) government intervention
for the application of psychological law of consumption, there should be a capitalistic economy without any government intervention. this law is not application to socialist economy.
2. importance of consumption
psychological law of consumption has a great importance. some of the reasons for the implication of this law in the economy are as follows:
(a) need of government intervention
this law is in the concept that there should be government intervention in the economy. since consumption does not increase as the increase in income, the economy is not self-adjusting. as a result, aggregate unemployment will arise in the economy. in such a situation, government can formulate various kinds of public policies and decrease or remove unemployment by intervention.
(b) equilibrium of under- employment
psychological law of consumption is based on the equilibrium of under-employment. the point of effective demand which determines the level of employment is not the state of full employment rather it is the point of under-employment because people do not use all part of their uncreased income in consumption expenditure. this will result in the decrease in demand. unless all parts of one's income are used in consumption expenditure the state of full employment will never occur in the economy.
(c) importance of investment
according to law of consumption in the short run, there won't be any change in the propensity to consume. the consumption expenditure increase less than proportionately as compared to the increase in income . so, due to stability of consumption function the gap between income and consumption will increase. this will create the situation of unemployment. so, to reduce or remove the gap between income and consumption there is a great importance for investment because investment is also a kind of consumption or consumption expenditure.
(d) declining tendency of the marginal efficiency of capital
in capitalistic economy the demand for consumption goods does not increase proportionately as the increase in income of the people. as a result of this the stock of produced goods will increase . to sell this increased stock of goods, the price has to be reduced. this will decrease the profit. on the other hand, if production is reduced the marginal efficiency of capital will automatically decline. the entrepreneurs will reduce the demand for capital goods. this situation can be removed by increasing propensity to consume. so, to increase consumption there is a great importance of propensity to consume.
(e) explanation of depression
in developed countries the marginal propensity to consume is less as compared to poor countries or under-developed countries. that is , consumption expenditure is far lower than the income. thus, most part of the income will be saved. due to excessive saving, the aggregate supply will be far more than the aggregate demand. as a result of this depression and the state of unemployment will arise in the economy.
(f) explanation of induced investment
the marginal propensity to consume is very high in under-developed as well as developing countries. therefore, in such countries the consumption expenditure increase as the national income increases. but the gap between the consumption expenditure and national income will be very small or negligible. similarly, in such countries emphasis is given to the investment in such development projects which will increase the income level in the long run. this law has great importance in explaining the induced investment.
