How to Induce Consumption Propensity

In general, consumption propensity is nothing more than that of human tendency, with a variation in income, in relation to their expenditure on goods and service for their personal or organizational consumption. In general, human tendency is such that as their income increases, consumption also increases. How much consumption goes up in response to an increase their income relies on their marginal propensity to consume. According to Keynesian notion in relation to human consumption behavior is such that, with an increase in income, consumption also increases but not by as much as there is an increase in income. As a result there is a gap between consumption and income level which results in a fall in aggregate demand, output and employment. An increase in aggregate demand which results an increase output and employment with economic growth can only be achieved by raising consumption. Hence, consumption propensity of the community should be raised by policy measures so that economy can be boost up in all around.

1- How to induce consumption propensity or measures to raise propensity to consume

There are some factors which induce consumption propensity. These factors are widely known as measures to raise propensity to consume, which have been mentioned as follows.

1.1- Income Redistribution

A redistribution of income in favors of the poor tends to rise propensity to consume. It is because marginal propensity to consume of the poor is higher as their basic needs to spend  are higher in comparison to the rich. Therefore, consumption propensity can be raised by transferring income from the rich to the poor through taxation and public spending policy.

1.2- Social Security Measures

Social security measures also help to increase consumption propensity. Provisions for unemployment relief, free medical facilities, old-age pension etc. reduce people's expectations of future uncertainties of their lives, hence tendency to save goes down and consumption propensity goes up. Hence, such social security provisions tend to raise consumption propensity.

1.3- Credit Facilities

Cheaper and easy credit facilities also help to raise consumption propensity. when the provision to provide loans easily at a low interest rate is made in an economy, people tend to buy durable consumption goods like motor bikes, cars, and other so many home appliances. Consequently, propensity to consume goes up.

1.4- Advertisement

A shower of advertisement of goods and services makes consumers familiar with the uses of them and with that the consumers are motivated to consume them. Such a motivational measure of the advertisement on goods and services induces consumption propensity.

1.5- Transportation Facility

Transportation facilities ease the movement of goods from production centers to different parts of the country. As a result, the size of market expands and prices also may fall due to a reduction in transportation cost. Goods become available for the consumers in their respective towns and their consumption goes up. Hence, all these tend to raise propensity to consume.

1.6- Urbanization

Urbanization is also an important measure to raise consumption propensity. when urbanization in a specific area takes place, people migrate to the urban area from rural areas. The migrants are attracted by new products and also influenced by demonstration effect in urban area. This makes them tends consume more and as a result propensity to consume goes up.

1.7- Increase in Wage Rate

An increase in wage-rate has a positive impact on consumption to some extend. So wage-rate should be increased with an increase in productivity of labor in order to raise propensity to consume. However high wage rate sometimes may lead to unemployment with a fall in labor demand, hence  it should be maintained in such a way that there is no fall in employment but rise in consumption.

1.8- Fiscal Policy,

Fiscal policy plays a key role to affect consumption expenditure. If government levies high excise duties, sales tax, and high direct tax, consumption propensity adversely affected. Hence, policies like lower tax, progressive tax, tax release etc. helps to raise propensity to consume. So, fiscal policy should be formulated in such a way that propensity to consume can be raised.

2- Consumption Function Puzzle

Empirical studies on consumption had been made by a noted American economist Kuznets using long-term times series data in mid-20th century and estimated a consumption function which contradicted Keynes' consumption function. Keynes' consumption function was found to be correct on the basis of cross-section studies of household budget data and short-term time series data. This contradiction between Kuznets empirical findings and Keynes' consumption function is known as consumption function puzzle.

To resolve the contradiction between Keynesian consumption function and Kuznets findings, many economist made tremendous efforts and and they have estimated some other theories of consumption function like Relative Income Theory of Consumption, Life Cycle Theory of Consumption, Permanent Income Theory of Consumption etc. We will discuss on these theory in next chapter.

In order to make a comparative study between Keynes' consumption function and Kuznets findings let's write them in algebraic form and present diagrammatically.

Keynes' consumption function C = a + bY ..........(i)

Where;

a = Autonomous consumption

b = Marginal propensity to consume or ΔC/ΔY

Autonomous consumption represents a certain consumption even when income is zero. It is possible when people live on their past income or borrowing form others. Hence it is constant and does not vary with income.

The above consumption function shows that average propensity to consume (C/Y) falls with an increase in income. This can be known by comparing the slopes of rays as shown in the following diagram.

In the diagram, the slope of the ray 0A at income level Y1 is greater than the slope of 0B at income level Y2, (0A>0B). This shows that APC falls when income increases.

Kuznets consumption function C = bY ........(ii)

Kuznets consumption function is with no autonomous consumption. It implies that consumption function starts from the origin and is very near to unity line. It shows that propensity to consume is very high. From his empirical studies Kuznets estimated that average propensity to consume was nearly 0.9 and people were tend to save only 0.1. Thus, his study focused that there was no tendency to fall in average propensity to consume with an increase in income.

Kuznets consumption function is depicted in the following diagram.

In the above diagram, the slope of the ray 0A at income level Y1 is equal to the slope of 0B at income level Y2, (0A=0B). This shows that APC does not change when income increases. It implies that APC does not fall with an increase in income. Thus Kuznets consumption function contradicts Keynes' consumption function.

From the above discussion it can be concluded that the implications of Keynes' consumption function and Kuznets consumption function are different. According to Keynes' consumption function APC falls when there is an increase in income where as according to Kuznets APC does not fall with an increase in income and the propensity to consume is much higher in comparison of Keynes' APC.

Some economists have tried to reconciliate between these two types of consumption functions and have concluded that Keynes' consumption function is short-run consumption function whereas Kuznets is concerned with long-run and referred as long-run consumption function. In the long-run, short-run consumption function shifts upward and long-run propensity to consume is higher as compared to short-run.