Consumption function

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. 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: C = a + b × Y d {displaystyle C=a+b imes Y_{d}} where a {displaystyle a} is the autonomous consumption that is independent of disposable income; in other words, consumption when income is zero. The term b × Y d {displaystyle b imes Y_{d}} is the induced consumption that is influenced by the economy's income level. The parameter b {displaystyle b} is known as the marginal propensity to consume, i.e. the increase in consumption due to an incremental increase in disposable income, since ∂ C / ∂ Y d = b {displaystyle partial C/partial Y_{d}=b} . Geometrically, b {displaystyle b} 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. b ∈ ( 0 , 1 ) {displaystyle bin (0,1)} . Keynes also took note of the tendency for the marginal propensity to consume to decrease as income increases, i.e. ∂ 2 C / ∂ Y d 2 < 0 {displaystyle partial ^{2}C/partial Y_{d}^{2}<0} . 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.