10 Major Implications of Consumption Function

The following points highlight the ten major implications of consumption function according to Keynes. The implications are: 1. Vital Importance of Investment 2. General over Production 3. Repudiation of Say’s Law 4. Need for State Intervention 5. Over Saving Gap 6. Decline in MEC 7. Income Propagation 8. Under Employment Equilibrium 9. Secular Stagnation 10. Turning Points of Trade Cycle.

Implication # 1. Vital Importance of Investment:

One of the most important implications of Keynes’ psychological law of consumption is that it brings about the crucial importance of investment if we want to attain higher level of income and employment. The law says when income increases the gap between income and consumption increases.

The gap is to be filled by bringing more and more investment failing which there will be shortage of effective demand and the economy would slip down. Thus the law highlights the vital importance of investment.

Implication # 2. General over Production:

Since the marginal propensity to consume is less than unity, with every increase in income, consumption would tend to lag behind income which would result in overproduction and unemployment. Thus the law tells us that there can occur a general overproduction and unemployment.

Implication # 3. Repudiation of Say’s Law:

Keynes with the help of his law of consumption repudiates Say’s law which states supply creates its own demand. Since the marginal propensity to consume is less than unity all that is supplied is not automatically demanded. The supply fails to create its own demand resulting in glut of products in the market.

Implication # 4. Need for State Intervention:

As there is no automatic and self-adjusting mechanism between supply and demand the government should interfere actively to ensure that aggregate effective demand does not fall below aggregate supply.

Implication # 5. Over Saving Gap:

Since the increase in consumption expenditure does not keep pace with the increase in income, there arises the danger of over-saving gap. This danger is more for rich countries than for poor countries.

Implication # 6. Decline in MEC:

As a result of the propensity to consume remaining stable with an increase in income the expected rate of profitability or the marginal efficiency of capital may tend to decline. This can be prevented only by increasing consumption with an increase in income because ultimately the decisions to undertake investments are guided by the volume of consumption.

Implication # 7. Income Propagation:

Keynesian theory explains the slow nature of income propagation. Since the marginal propensity to consume is less than unity, injection of increasing purchasing power into the income stream leads to smaller and smaller successive increments to income.

Implication # 8. Under Employment Equilibrium:

Equilibrium would be attained at full employment only if investment demand happens to be equal to the gap between aggregate income corresponding to full employment and aggregate consumption expenditure out of that income. But Keynes believed that the typical investment demand would not be adequate to fill the gap between the amount of income corresponding to full employment and the consumption demand out of that income. As such the aggregate demand and supply schedules would intersect at a point less than full employment.

Implication # 9. Secular Stagnation:

With the increase in income, since consumption cannot be easily increased and investment demand becomes weaker and weaker the economy may sooner or later reach a stage where it may not be able to provide outlets for its growing savings which is necessary for maintaining full employment. This stage is known as secular stagnation. Such a situation could be avoided if the consumption function were not stable.

Implication # 10. Turning Points of Trade Cycle:

Keynes’ psychological law of consumption is very helpful in explaining the turning points of the trade cycle. When the business cycle reaches the highest point of prosperity, income has increased, but the marginal propensity to consume being less than unity, consumption does not increase correspondingly and the result is the downward start of the cycle.

Similarly when the business cycle reaches the lowest point, income has declined very low but since people do not reduce their consumption to the full extent of decline in income, the upward phase of the cycle starts. Thus consumption function occupies a very important place in the theory of employment.

To Keynes investment refers to real investment which adds to capital equipment. It leads to increase in the level of income and production by increasing the production and purchase of capital goods. Real investment is to be increased to maintain stable national income growth. According to Keynes investment depends on marginal efficiency of capital and rate of interest.