3 Main Assumptions of Keynes’ Psychological Law | Consumption Function

The following points will highlight the three main assumptions of Keynes’ psychological law.

1. It presumes a constant psychological institutional complex.

In other words, it means that consumption depends upon income alone and other institutional and psychological factors such as income distribution, price level, population growth, fashion, tastes and habits do not changes.

In the short period, it may not be unrealistic to make such an assumption. It is, however, important to realise that these psychological and institutional factors may change in the short-period too on account of certain dynamic influences.

2. The second presumption is that there exist normal circumstances and not extraordinary circumstances like war, revolution, hyperinflation etc. Under these extraordinary circumstances, not to speak of the propensity to consume, even the most fundamental and general laws of economics are bound to undergo a change. Thus, it is clear that Keynes’ Psychological law of consumption will hold good under normal circumstances only.

3. It implies a socio-economic set up based on laissez-faire under which the State is precluded from interfering in the economic activities carried on by individual entrepreneurs. If the community is poor, the choice between consumption and saving has little significance (as there is likely to be more consumption). On the other hand, if the community is rich, drastic regulation of the state may affect saving and spending decisions of the community thereby impairing the working of the psychological law. This law, therefore, holds either in the free-enterprise economy or, at the most, in a mixed economy.

These assumptions, though important in a sense to Keynes’ psychological law, will have to be dropped to make consumption function fit with the realities in the long period. Keynes’ law based on these assumptions may be regarded as a rough approximation of the actual macro-behaviour of free consumers in the normal short period.

What is vitally stressed in Keynes’ law is the failure on part of people to spend on consumption the full amount of an increment in income. This results in a ‘low-consumption’ and ‘high-saving’ economy. Technically speaking “it is not just the propensity to consume but the marginal propensity to consume that is supposed to be stable under the above psychological and institutional assumptions. In other words, the position and shape of the consumption function are such that the amount of consumption depends on income alone and the amount of income saved increases as income increases.”