Average and Marginal Propensity to Consume

propensity to consume has been divided into two parts viz. average propensity to consume and marginal propensity to consume.
1. average propensity to consume
average propensity to consume is the ration of aggregate consumption to aggregate income. therefore, ration of consumption to income is known as average propensity to consume. average propensity to level of income. thus, the relationship between the gross national income and gross consumption expenditure is the average propensity to consume.
2. marginal propensity to consume
marginal propensity to consume is the relationship of the change in consumption to the change in aggregate income. it is also known as the rate of change in average propensity to consume. the change in consumption expenditure on the basis of the ration of the following year is given by the marginal propensity to consume. thus, marginal propensity to consume is obtained by dividing change in consumption expenditure with change in aggregate income.

phychological law of consumption

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.

determinants of consumption function

consumption function is influenced by various factors. consumer's propensity to spend, different situations, exhibition influence, etc. are the factors that influence the consumption function. analyzed the factors that determine the consumption function by dividing them into the following two sections:
1. subjective factors 2. objective factors
these subjective and objective factors can be explained ad follows:
1. subjective factors
subjective factors are also known as psychological factors because these are internal factors that determine the consumption function. these factors are related to human behavior and habits, social customs and traditions. by these factors the behavior of individuals as well as the behaviors of the entrepreneurs are influenced. in this manner, subjective factors are also divided into two parts viz. individual motives and business motives.
(a) individual motives
people cut down their consumption due to various individual reasons. such changes in consumption affects the consumption function in various ways. individual motives are divided into the following eight parts:
1. motive of foresightedness
people cut down their current consumption for the sake of their children future. this will result in the decrease in consumption function.
2. motive of precaution
people cut down their current consumption in order to tackle the miss happenings in the future.
3. motive of improvement
some people cut down their current consumption in order to improve their future life style. this will also reduce the current consumption.
4. motive of independence
some people improve their future life styles by reducing current consumption. this will also reduce current consumption vecause people are of the concept that they would be independent on the future. consumption function decrease in this manner also.
5. motive of pride
people are of the motive of retaining their pride in the future by maintaining a good economic status of their children with the reduction in current consumption. this will also reduce the consumption function.
6. motive of enterprise
some people even cut down their current consumption in order to save for the required investment in establishing an enterprise in the future. in this situation also the consumption function will be reduced.
7. motive of avarice
some people do not spend even in the necessary situation due to avarice as a result consumption function will decrease.
8. motive of calculation
there are some people in the society who calculate interest, profit,etc. fro their saving. so, such people will cut. down their present consumption to save for earning interests, profits,etc. in the future. such people will reduce their consumption function.
(b) business motives
among various factors determining the consumption function business motive is also one. due to business motives the individuals and the government cut down their current consumption. the business motive can be explained as follows:
1. motive of enterprise
some people come forward facing the risks to carry out the business activities. such, people cut down their current consumption to increase the savings that will be required for the development and expansion of their business in the future.
2. motive of liquidity
some entrepreneurs cut down their current consumption to increase the saving for liquidity that may be required to solve the problems that arise while running the business. this will also result in the decrease in consumption function.
3. motive of income improvement
any enterprising will required a huge amount of capital to increase the income. so, to increase work efficiency the current consumption is cut down. this will also decrease the propensity to consume.
4. motive of financial prudence
some entrepreneurs are farsighted and they cut down their current consumption for new investments in the future. to run the financial business also they cut down their current consumption. this will also result in the decrease in consumption function.

2. objective factors
factors determining consumption function are such exogenous factors which sometimes bring about changes quickly and some other times bring about changes very slowly. some of such factors are as follows:
(a) fiscal policy
change in fiscal policy by the government brings about the changes in consumption and income. of the government increases the tax rate through fiscal policy then disposable income will decrease. this will result in the decrease in consumption. in contrary to this, if the government reduces the tax rate through fiscal policy, then the disposable income will increase, increasing the propensity to consume.
(b) windfall gains or losses
future expectations also affect the propensity to consume. if gains increase unexpectedly then consumption will also increase and if losses increase unexpectedly, then propensity to consume will decrease.
(c) future expectations
future expectations also affect the propensity to consume. due to possibility of rise in price in the future or possibility of war, the current demand for goods will increase. but contrary to this. if there is a possibility of decrease in price in the future, then current demand for goods will decrease.
(d) rate of interest
rate of interest also determines the consumption function. if the rate of interest increases then people will start saving. as a result current consumption will decrease . on the other hand, if the rate of interest decreases, then the people won't be in favour of saving. this will result in the increase in the propensity to consume.
(e) distribution of income
if the national income is equally distributes then the propensity to consume will be less. in such a situation, the income of people won't increase in high proportion. in contrary to this, if the national income is distributed unequally, then most part of the national income will be in the hands of rich people and their propensity to consume will be low. in such a situation there won't be a possibility for the increase in income of the poor people.
due to changes in these various factors the changes in the income of people will be resulted, and changes in the propensity to consume will occur. therefore, income is taken as the main factor that affects the propensity of consume. other factors are taken to have uncertain effects. these effects are effective only in the long run.

measures to increase in the propensity to consume

In the short run propensity to consume is stable because this can't be changed in a short period. increase in consumption function also increase output ,employment and income,since increase in consumption function has positive effect in the economy, this has to be increased . in the long run propensity to consume can be increased in the following ways:
1. redistribution of income
government should levy progressive tax on the rich and people with high income and provide various subsidies to the poor people. so, redistribution of income from rich people to poor people will increase the propensity to consume of the poor people.
2. wage policy
increase in wage rate increases the propensity to consume in the long run because daily wage earners are the people with low income. the more the increase in the wage rate, the higher is the consumption of such people. thus, propensity to consume can be increased with the increase in the wage rate.
3. increase in the social security
government can increase the propensity to consume by increasing the social security. unemployment allowances, pension,health insurance, etc. also, increase the consumption function of the people.
4. credit facility
easy and cheap credit facilities will enable the people to purchase durable goods such as motorcycles, televisions, fridges, etc. this will increase the consumption of people. similarly , installment and hire and purchase schemes will also increase the propensity to consume.
5. urbanisation
urbanisation also increase the propensity to consume because of the various modern facilities and necessities the city people will consume More goods and services than the rural people.
6. advertisement and publicity
various advertisements and publicity of goods and services also increase the propensity to consume of the people . newspapers, radio, television, etc. are the media for advertisement and publicity of goods. advertisements and publicity inform the people about the new goods and services and motivate them in consuming such goods and services.
7. development of means of transport
development of various means of transport also increase the propensity to consume of the people. goods produced at one place can be taken to the consumers easily by means of transportation. this will increase the consumption function of the consumers.

paradox of thrift

the amount left over after the consumption by an individual or society is known as the saving. people do not spend all of their incomes on consumption. since people are always worried about their future, they save some part of their incomes. this will free them from their future economic worries. individual saving will determine the national saving. though national saving is composed of individual saving, the effects of these savings in the economy are of different types.
the classical economists were of the view that the saving was good for the economy because according to them the investment was determined create national saving and this national saving would convert into national investment. therefore, the economists were of the concept that the saving and investment were inseparable from each other. but another economists criticized the concept of saving that was given by the classical economists. they were of the concept that saving would decrease the consumption in the economy. they explained that this would lead to the situation of under consumption. thus, decrease in consumption will result in the decrease in effective demand and as a result there will be over-production, unemployment and economic crisis in the economy.
another economists had a different view in regard to saving. he criticism the concept of saving given by the classical economists and said that saving being good or bad depends upon its use. if saving is invested then there won't be any decrease in effective demand. in such a situation, Savina won't have any kind of harm in the society. but if saving is kept hoarding instead of investing then this will have negative effect in the economy. from individual point of view saving is a virtue but form the social point of view saving is a social evil. if any individual cuts down the consumption and saves some part of the income, then it is good for that individual. but this won't help the society in any way. the reason for this is that the expenditure of one personify the income of the other. in a given period the saving of one individual is equal to the decrease in the income of the other individual. this will result in the decrease in the saving of the second individual or party. so, the more the single individual saves the less will be the social saving. explained the concept of saving under the macro-economics in accordance to social saving rather than individual saving, thus saving is vice but not virtue.
so , saving decrease effective demand in the economy resulting a decrease in the price and profit.as a result, investors will be discouraged to invest. this will further decrease the employment, production and income which in turn decrease the saving. this will convert the saving into social evil. so in the beginning saving is a virtue to the individual but to the society and the nation it will become harmful. this in the end and also harms the individual. therefore, saving turns in to misfortune. this is known as the paradox of thrift.

concept of investment

1. in general investment means the purchase of shares securities and any sorts of assets. but in economics such activities are only known as transfer of ownership because this sort of investment does not increase the aggregate income and employment. therefore, such investment-is known as financial investment because this won't increase real investment. but in economics any transaction that increase the real capital and yields additional income is known as investment. for this reason money invested in the purchase of shares and securities of different companies cannot be taken as investment. such transactions don't increase the national income and national capital. thus any economic replication with the use of additional capital which increases the capacity of national production and additional income is known as investment.so, investment is the increase in supplant of capital which helps in the increase in the production and productivity. so , to spend on shares of different industries fixed capitals such as machinery and building, preparation of consumption goods by employing various raw materials, expenditure on development and construction, etc. area known as investment.
2. investment means increase in the real capital fund. in other words investment is that part of the income which is spent to earn more income with the employment of capital goods. all the expenditures that her involved when establishing new factories, increasing the efficiency of old factories, improvement and expansion of transportation, construction of various buildings, etc. are taken to be investment. investment is also analyzed from individual as well as social point of view as the analysis of saving. personal investment is also of two types. they are:
3. 1. financial investment
4. when an individual uses the personal saving in purchasing shares and securities or bonds of any existing companies then that is known as financial investment. financial investment does not increase the quantity of real capital in the society because in such investment one does the selling and the other doer the purchasing. this won't increase the aggregate investment.
5. 2. real investment
6. if an individual uses the savings in a new company or construction of a new building instead of purchasing old shares and debentures of existing companies, then this will increase the real capital. this is known as the real investment. the main objective of real investment is to increase the capital assets and the amount of goods.

types of investment

Generally, investment can be dividend in to the following types:
1. gross and net investment
in any economy, the aggregate real investment is known as gross investment. such investment reflect es the amount spent on gross assets. all real investment in any sectors will not be used to increase the production capacity. some part of it will be used in the construction of basic infrastructure for production, for repairing and maintenance of old and broken machinery's and for keeping up-to-data the depreciation of fixed capital so, some part of grose investment will also be in the form of substitution demand. this will be used in repairing, maintenance and substituting old and broken machinery's. all these expenditures are known as Gross investment. GI = NI + Depreciation. net investment is that part of the investment which is used in increasing the gross production capacity which is exist in the economy. gross investment and net investment will be equal to each other when in the economy there won't be any problem of repairing and replacing old and broken machinery's as well as there will be no need of depreciation. but in real world such situation will not occur. for this reason net investment will be less then gross investment. if depreciation is deducted from the Gross investment, then net investment will be obtained.
2. private and public investment
investment by an individual or private institution in various industries and business withe the motive of earning profit is known as private investment. this type of private investment depends upon the marginal efficiency of capital is more then the rate of interest then the investment will increase. otherwise investment will decrease. on the other hand investment by government sectors or various bodies of government is known as public investment. in such investment public benefit is stressed more then the profit. investment in construction of roads, brides, canals, hospitals, educational institutions, transportation communication sectors, etc. is known as public investment. such investment will have indirect benefits rather than direct benefits.
3. induced and autonomous investment
investment determined by the change in direct production and income is known as induced investment. thus, this is known as the function of income. that is: so, induced investment is directly proportional to the income. in other words, induced investment increase as the income increase. the increase in the disposable income of the propel in the society increase the effective demand. so, quantity of induced investment depends upon the quantity of income.