Let us make an in-depth study of the Keynes’ Psychological Law of Consumption.
Keynes’ Psychological Law of Consumption is an important tool of economic analysis in Keynesian economics.
This law is basic to Income Theory.
This law is a statement of a very common tendency that when income increases, consumption also increases but not to the same extent as the increase in income. “The psychology of the community is such that when aggregate real income is increased, aggregate consumption is increased, but not by so much as income.”
Keynes further remarked in his General Theory: “The fundamental psychological law, upon which/ we are entitled to depend with great confidence… firm our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule, and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.” This law was popularly known as ‘Propensity to Consume’ and subsequent writers called it ‘Consumption Function.’
Keynes’ Psychological Law of Consumption depends upon three related propositions:
(i) That when the aggregate income increases, consumption expenditure will also increase but by a somewhat smaller amount;
(ii) That an increment of income will be divided in some ratio between saving and spending;
(iii) An increase in income is unlikely to lead either to less spending or less saving than before.
The first proposition is vital to Keynes’ law of consumption. The other two propositions are important observations but Keynes Theory stands even when these are not obtained. All this means that consumption (besides other factors) essentially depends upon income (or net income or disposable income) and that income receivers always have a tendency to spend less on consumption than the increment in income.
It may, however, be understood that consumption in Keynesian economics means spending which is done to acquire consumer goods, such as food, clothing, reading, house furnishings etc. The main difference, between consumer spending and investment spending is that the consumer makes his purchases to satisfy his or that of his family’s needs directly; in other words, he does not buy things for resale while the investor spends for further production purposes.