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The consumption function is a mathematical expression of consumer spending, based on autonomous and induced spending. Critics argue it doesn’t consider future income. The function involves adding standalone expenses and disposable income spent on induced spending. Self-employed expenses remain constant. Marginal consumer propensity measures how much of an increase in income consumers will spend. The consumption function is also known as the absolute income assumption and was developed by John Maynard Keynes. The permanent income and life cycle hypotheses try to correct its flaws.
The consumption function is an attempt to express, mathematically, the way in which consumer spending works. It is based on two types of spending: autonomous spending that is constant and induced spending that varies with income levels. Critics of the consumption function suggest that it does not take future income into account.
There are several ways to express the consumption function, but they all involve adding two numbers together. A figure is simply the standalone expense. The other figure is disposable income available to consumers multiplied by the proportion of disposable income that is spent on induced spending, which is spending that varies with income levels. It can include goods and services seen as luxuries, but it can also include buying better quality products used for basic needs.
Self-employed expenses are those that remain the same regardless of people’s income. In theory, this would include spending on essentials such as rent or mortgage payments, basic foodstuffs and clothing. It is possible that total self-employed expenditure is greater than total income. This would happen where the economy is in difficult conditions and, as a general average, people are dependent on savings or borrowing to finance their basic needs.
The consumption function uses a measure known as marginal consumer propensity. This measures how much of any increase in income consumers are likely to spend. Most economists believe that this is not a constant factor, but that it decreases with income. This means that although consumer spending increases with income, it does not increase as quickly. This is because the more money people have, the more likely they are to feel that their needs are met and to be in a position to decide against further “wasteful” spending.
The consumption function is also known as the absolute income assumption. It was originally developed by economist John Maynard Keynes in the early 20th century. Modern studies find it to be a reliable guide in the short term, but not as accurate in the long term.
There are several theories that try to correct this flaw. The permanent income hypothesis takes into account that people are more likely to borrow money for “unnecessary” expenses, because they hope to finance this money with future income, whether it is a gain during their working life or windfall gains, such as an inheritance. The life cycle hypothesis works in a similar way and suggests that a consumer’s annual spending constitutes a stable percentage of the total income he expects to earn over his lifetime, taking retirement into account.
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