Factors
Affecting Consumption Functions: Subjective and Objective Factor!
According
to Keynes, two types of factors influence the consumption function: subjective
and objective. The subjective factors are endogenous or internal to the
economic system itself. The subjective factors relate to psychological
characteristics of human nature, social structure, social institutions and
social practices.
These are
likely to remain more or less stable during the short period. Established
behaviour pattern undergoes material change only over long periods. These
factors fundamentally determine the form of the consumption function (i.e.,
slope and position of the propensity to consume, the С curve).
The
objective factors affecting the consumption function are exogenous, or external
to the economy itself. These factors may at times undergo rapid changes. Thus,
objective factors may cause a shift in the consumption function.
Subjective
Factors:
Subjective
factors basically underlie and determine the form of the consumption function
(i.e., its slope and position).
The
subjective factors concerned are:
(1)
behaviour patterns fixed by the psychology of human nature
(2) the institutional
arrangements of the modern social order, and social practices relating to the
behaviour patterns of business firms with respect to wage and dividend payments
and retained earnings, and the institution controlling the distribution of
income.
Human
behaviour regarding consumption and savings out of increased income depends on
psychological motives.
First,
there are motives which “lead individuals to refrain from spending out of their
incomes.”
Keynes
enlists eight such motives:
1. The
Motive of Precaution:
The desire
to build up a reserve against unforeseen contingencies.
2. The
Motive of Foresight:
The desire
to provide for anticipated future needs, e.g., in relation to old age, family
education, etc.
3. The
Motive of Calculation:
The desire
to enjoy interest and appreciation, because a larger real consumption, at a
later date, is preferred to a smaller immediate consumption.
4. The
Motive of Improvement:
The desire
to enjoy a gradually increasing expenditure since it gratifies the common
instinct to look forward to a gradually improving standard of life rather than
otherwise.
5. The
Motive of Independence:
The desire
to enjoy a sense of independence and the power to do things.
6. The
Motive of Enterprise:
The desire
to secure a mass de manoeuvre to carry on speculation or establish business
projects.
7. The
Motive of Pride:
The desire
to possess or to bequeath a fortune.
8. The
Motive of Avarice:
The desire
to satisfy pure miserliness, i.e., unreasonable, but insistent abstinence from
expenditure as such.
To this,
Keynes adds a corresponding list of motives on consumption such as enjoyment,
short-sightedness, generosity, miscalculation, ostentation and extravagance.
Subjective
motivations also apply to the behaviour patterns of business corporations and
governmental bodies. In this respect, Keynes listed the following motives for
accumulation:
(a) The
Motive of Enterprise:
The desire
to do big things, to expand, to secure resources to carry out further capital
investment.
(b) The
Motive of Liquidity:
The desire
to face emergencies and difficulties successfully.
(c) The
Motive of Improvement:
The desire
to secure a rising income and to demonstrate successful management.
(d) The
Motive of Financial Prudence:
The desire
to ensure adequate financial provision against depreciation and obsolescence
and to discharge debts.
Keynes
maintains that the strength of all these motives may vary considerably
according to the institution and the organisation of the economic society.
Since economic and social institutions and organisations are formed by habits,
race, education, morals, present hopes and past experiences, techniques of
capital equipment and the prevailing distribution of wealth and established
standard of life — all these factors are unlikely to vary in the short run.
They, therefore, affect secular progress only very gradually. In other words,
these factors, subject to slow change and over a long period, may be considered
as given or stable.
Objective
Factors:
Objective
factors, subject to rapid changes and causing violent shifts in the consumption
function, are considered below:
1. Windfall
Gains or Losses:
When
windfall gains or losses accrue to people their consumption level may change
suddenly. For instance, the post-war windfall gains in stock exchanges seem to
have raised the consumption spending of rich people in the U.S.A., and to that
extent, the consumption function was shifted upward.
2. Fiscal
Policy:
The
propensity to consume is also affected by variations in fiscal policy of the
government. For instance, imposition of heavy taxes tends to reduce the
disposable real income of the community; so its level of consumption may
adversely change. Similarly, withdrawal of certain taxes may cause an upward
shift of consumption function.
3. Change
in Expectations:
The
propensity to consume is also affected by expectations regarding future
changes. For instance, an expected war considerably influences consumption by
creating fears about future scarcity and rising prices. This leads people to
buy more than they immediately need, i.e., to hoard. Thus, the ratio of
consumption to current income will rise, which means that the consumption
function will be shifted upward.
4. The Rate
of Interest:
In the long
run, substantial changes in the market rate of interest may also influence
consumption. A significant rise in the rate of interest may induce people to
reduce their consumption at each income level, because people will save more in
order to take advantage of the high interest rate.
Moreover,
if the rate of interest rises, then the lending of the present saving (realised
by consuming less) will enable one to obtain an even larger quantity of
consumption goods in the future. Keynes, thus, argues that “Over a long period,
substantial changes in the rate of interest probably tend to modify social
habits considerably.”
In addition
to these four factors, Keynes also mentioned changes in the wage level, in
accounting practices with respect to depreciation (indicating the difference
between income and net income), as the objective factors affecting the
consumption function.
Keynes’
disciples, however, considered his list of objective factors inadequate and
have listed others which we consider below:
1. The
Distribution of Income:
With the
given level of income, aggregate consumption will vary if income is distributed
in different ways among the people. A community with a greatly unequal
distribution of income tends to have a low propensity to consume on the whole,
while a community with a high degree of equality of income will have a high
propensity to consume in general.
Thus,
redistribution of income through fiscal measures of the State will affect the
propensity to consume. Joan Robinson explicitly states that “the most important
influence on the demand for consumption goods is the distribution of income.”
It may be noted here that Keynes does not specify income distribution as an
objective factor but includes it under the common heading of fiscal policy.
2. Holding
of Saving — Liquid Assets:
According
to Kurihara another factor affecting the consumption function is the volume of
accumulated savings by the people. The larger the amount of such savings (i.e.,
holding of liquid assets, like cash balances, savings accounts and government
bonds), the more likely people will tend to spend out of their current income,
because the holding of savings in the form of liquid assets, will give them a
greater sense of security. A change in the real value of such assets held by
them, owing to general price changes, might also affect the consumption
function.
3.
Corporate Financial Policies:
Kurihara
observes that business policies of corporations with respect to income
retention, dividend payments, and re-investments, produce some effect on the
propensity of equity holders to consume. A cautious dividend policy followed by
corporations and corporate savings will reduce the consumption function by
reducing the residual disposable income of the shareholders (who are consumers,
in a way).
All the
above-mentioned factors will affect the consumption function in one direction
or another. However, all of them are relatively unchanging in the normal short
run and, therefore, cannot explain the changes in total consumption during the
short-run period. Income is the only variable which will change considerably in
the short run and affect consumption. Thus, it may be asserted that consumption
varies only in the level of income.
