The consumption function is a mathematical expression of consumer spending, based on autonomous and induced spending. Critics argue that it does not consider future revenue. The function uses the marginal propensity to consume and is also known as the absolute income hypothesis. The permanent income and life-cycle hypotheses attempt to address its shortcomings.
The consumption function is an attempt to express, mathematically, how consumer spending works. It is based on two types of spending: constant autonomous spending and induced spending that varies according to income level. Critics of the consumption function suggest that it does not account for future revenue.
There are several ways to express the consumption function, but they all involve adding two digits. A figure is simply self-spending. The other figure is the 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 could include goods and services seen as luxuries, but it can also include buying better quality products used for basic needs.
Autonomous spending is spending that stays the same regardless of people’s income. In theory, this would include spending on basic necessities such as rent or mortgage, basic food and clothing. It is possible that total autonomous expenditure is greater than total income. This would happen where the economy was in difficult shape and, taken as an overall average, people were relying on savings or loans to finance their basic needs.
The consumption function uses a measure known as the marginal propensity to consumer. This measures the amount of income increasing consumers are likely to spend. Most economists believe this is not a constant factor, but rather one that decreases with income. This means that although consumer spending increases with income, it does not increase as rapidly. This is because the more money people have, the more likely they are to feel their needs are met and to be able to decide against additional “wasteful” spending.
The consumption function is also known as the absolute income hypothesis. It was originally developed by economist John Maynard Keynes in the early 20th century. Modern studies find it to be a reliable short-term guide, but not as accurate in the long run.
There are several theories that attempt to correct this shortcoming. The permanent income hypothesis accounts for the increased likelihood that people will borrow money for “unnecessary” expenses because they expect to finance it with future income, whether it is wages during their working lives or failures, such as ‘inheritance. The life-cycle hypothesis works along similar lines and suggests that a consumer’s annual expenditure is a stable percentage of the total income expected to exceed his or her lifetime, accounting for retirement.
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