Objective Factors of Consumption Function

The following points highlight the eighteen main objective factors that influence consumption function according to Keynes. Some of the objective factors are: 1. Change in the Wage Level 2. Windfall Gains or Losses 3. Change in the Fiscal Policy 4. Changes in Expectations 5. Changes in the Rate of Interest 6. Financial Policies of Corporations 7. Holding of Liquid Assets and Others.

Objective Factor # 1. Change in the Wage Level:

Increase in wages will increase consumption. Therefore the consumption function curve will shift upward. If however, the rise in the wage rate is accompanied by a more than proportionate rise in the price level, the real wage rate will fall and consumption will decrease. This will tend to shift the consumption function curve downward. A cut in wage rate will reduce consumption and shift the curve downward.

Objective Factor # 2. Windfall Gains or Losses:

Unexpected gain will increase consumption and shift consumption function curve e.g., the windfall gain in American stock market in 1925 led to a rise in consumption. Unexpected losses lead to the downward shifting of the consumption curve.

Objective Factor # 3. Change in the Fiscal Policy:

The fiscal policy of the government relating to taxation, expenditure and public debt affect consumption. A reduction in taxation will leave more post-tax incomes with people which would tend to increase their expenditure on consumption. In contrast, an increase in taxation will reduce consumption. Progressive taxation and public expenditure on welfare programmes will shift consumption function upwards by altering the distribution of income.

Objective Factor # 4. Changes in Expectations:

If the consumers expect a shortage or rise in prices of certain goods, they may rush to purchase such goods far in excess of their current needs. This would raise the consumption function. Such things happen during war. On the other hand, if the people expect a plenty, or a decline in prices of certain durable goods, they would tend to postpone purchase of such goods, which would lower the consumption function.

Objective Factor # 5. Changes in the Rate of Interest:

If the interest rate is high the cost of holding money as liquid asset increases, people will find it less profitable to keep idle cash. They may begin to invest. This will reduce total consumption and increase saving. If on the other hand the interest rate is low people may find that keeping liquid cash would be more profitable. This will reduce savings and increase consumption.

Objective Factor # 6. Financial Policies of Corporations:

If corporations and companies retain more reserves and give lesser profits in the form of dividends, the disposable income of the shareholders will be smaller. On the other hand if more profits are distributed as dividends, more will be spent on consumption.

Objective Factor # 7. Holding of Liquid Assets:

Liquid assets in the form of cash balances, savings and government bonds in the hands of the consumers also influence the consumption function. If people hold larger liquid assets they will have a tendency to spend more out of their current income and the propensity to consume will move upward and vice versa.

Objective Factor # 8. The Distribution of Income:

If the income distribution is more even, then the propensity to consume will be high. If there is wide spread disparity of income, the income will go into the hands of a handful capitalists who have greater propensity to save than to spend. Hence the over-all propensity to consume will be less.

Objective Factor # 9. Attitude Toward Saving:

If the consumers value future consumption more than present consumption, they will tend to save more and consume less and the consumption function curve will shift downward. Such a tendency is reinforced by the state through compulsory provident fund, life insurance and other social insurance schemes to keep the consumption function low. In a high saving economy, consumption function is low.

Objective Factor # 10. Duesenberry Hypothesis:

According to James Duesenberry the expectation of an individual depends not on his current income but also on his past income and standard of living. Even if the current income is reduced, the individual might continue to spend the same amount on current consumption, out of past saving, because he has been accustomed to a particular standard of living.

He also talks about ‘demonstration effect’. He says that the consumption standards of low income groups are largely influenced by the consumption standards of the high income groups. Such habits will weaken the propensity to save and increase consumption.

Objective Factor # 11. Selling Effort:

Selling cost and advertisement may increase the consumption of one good at the expense of other. Nevertheless, given the level of income, an increase in selling effort may increase the total volume of consumer expenditure. But this factor has not been given much importance due to three reasons.

In the first place there is no independent measure of the volume of effective selling effort.

Secondly, this volume probably does not fluctuate much in the short period.

Thirdly, it has not been considered, at least, in the past, subject to social control.

Objective Factor # 12. Changes in Relative Prices:

Like selling efforts, changes in relative prices increase demand for some products at the expense of other products. Much attention has not been paid to this factor because there is no specific hypothesis as to which this influence is important and in which direction it operates.

Objective Factor # 13. Volume of Wealth:

The larger the wealth possessed by an individual the higher will be the propensity to consume. This is because when wealth is more the marginal utility would be lower and as such the weaker would be the desire to add to future wealth by reducing current consumption.

Objective Factor # 14. Demographic Factors:

Factors like size of the family, stage in the family life cycle, place of residence, occupation etc. affect consumption function. Other things remaining the same a large size family will spend more than a small size family.

Families with children of college age would spend more than those with children of primary age. Normally the urban families will have a tendency to spend more than the rural families. Farmers and small businessmen tend to spend less than service people. But changes in demographic factors, occur only in the long period and therefore be ignored in the short-run analysis.

Objective Factor # 15. Terms of Consumer Credit:

Easy availability of credit will increase the propensity to consume of consumer durables. In recent years, there has been a considerable increase in the volume of purchases of consumer durables financed by consumer credit and as such its cost and availability have assumed great importance.

Objective Factor # 16. Permanent Income:

It is also known as normal income. A family’s expenditure on consumption is determined not by its current income but by its permanent income. If the latter is more, consumption function will be more, or else it will be less.

Objective Factor # 17. Consumer Durables:

The short-run instability of consumption expenditure in relation to income is concentrated much in the area of consumer durables. The factors affecting the timing of purchase of durable goods can significantly affect aggregate demand causing irregularities between current consumption and income. The timing of purchase of consumer durables depends on nature and obsolescence of the existing stock.

Objective Factor # 18. Pigou Effect:

The changes in the real value of liquid assets also affect consumption function. This is known as ‘Pigou Effect’ or ‘Real Value of Money Assets Effect’ or ‘Wealth Effect.’ It was given by A.C. Pigou in 1943. He argued that when money wages are cut, prices fall and the value of money rises. This will result in the real value of assets such as stocks, shares, bank deposits, government securities, bonds etc. for example, if prices fall by 50 percent the real value of each rupee will be doubled because it will buy twice as much as it did before.

The increase in the real value of fixed assets will make their owners feel richer than before. They will therefore save less out of their current income and spend more on consumption. This will increase aggregate demand and output and will generate automatic full employment in the economy. As a result of Pigou effect the consumption function will shift upward. Pigou effect is based on the assumption of flexible wage, flexible absolute price and a constant stock of money.