PSYCHOLOGICAL LAW OF CONSUMPTION

• REVISION SERIES FOR STUDENTS OF MACRO ECONOMICS /BUSINESS ECONOMICS 2

• PSYCHOLOGICAL  LAW OF CONSUMPTION

• MACRO ECONOMICS
• ENGLISH LECTURE WILL BE AVAILABLE AT MY SECOND CHANNEL SHASHI AGGARWAL ECONOMICS AND LAW CLASSES
• QUESTION
• EXPLAIN KEYNES’S PSYCHOLOGICAL LAW OF CONSUMPTION WITH ITS IMPLICATIONS.
• HOW TO ATTEMPT: WITH IN 35 MINUTES

1. MEANING OF KEYNES PSYCHOLOGICAL LAW OF CONSUMPTION
2. ASSUMPTIONS
3. EXPLANATION WITH DIAGRAM
4. IMPLICATIONS

• PSYCHOLOGICAL CONSUMPTION

1. GIVEN BY KEYNES BASED ON THE RELATIONSHIP BETWEEN AGGREGATE CONSUMPTION AND INCOME. ALSO CALLED KEYNES’ FUNDAMENTAL LAW OF CONSUMPTION
2. KEYNES ,” THE PSYCHOLOGY OF THE COMMUNITY IS SUCH THAT WHEN AGGREGATE REAL INCOME IS INCREASED, AGGREGATE CONSUMPTION IS ALSO INCREASED BUT NOT BY SO MUCH AS INCOME.
3. MARGINAL PROPENSITY TO CONSUME IS ALWAYS POSITIVE BUT LESS THAN ONE.

• ASSUMPTIONS

1. NO CHANGE IN PSYCHOLOGICAL AND INSTITUTIONAL COMPLEX: EXCEPT CHANGE IN INCOME THERE IS NO CHANGE IN POPULATION,HABITS OF THE PEOPLE,TASTE ETC
2. NORMAL CONDITIONS:-NO DANGER OF WAR/DEPRESSION/BOOM
3. BASED ON LAISSEZ FAIR: APPLIES TO FREE AND PROSPEROUS ECONOMY. DOES NOT APPLY TO SOCIALISTIC AND UNDER DEVELOP ECONOMIES

• EXPLANATION
• PSYCHOLOGICAL LAW OF CONSUMPTION
• D
• EXPLANATION
• AS WE SEE FROM THIS GRAPH WHEN INCOME IS ZERO ,THEN CONSUMPTION IS MORE THAN ZERO. WE ARE USING PAST SAVING FOR SATISFYING OUR CONSUMPTION AT ZERO INCOME. AS INCOME GOES ON INCREASING CONSUMPTION GOES ON INCREASING AT DIMINISHING RATE
• MAIN PROPOSITIONS

1. INCREASED AGGREGATE INCOME LEADS TO INCREASED AGGREGATE CONSUMPTION
2. INCREASED INCOME IS DIVIDED BETWEEN CONSUMPTION AND SAVING=∆Y= ∆S+ ∆C
3. AN INCREASE IN AGGREGATE INCOME IS UNLIKELY TO LEAD EITHER TO LESS CONSUMPTION OR LESS SAVING THAN BEFORE

• IMPLICATIONS

1. STRATEGIC IMPORTANCE OF INVESTMENT: AS INCOME OR EMPLOYMENT DEPENDS ON CONSUMPTION AND INVESTMENT AND IN THE SHORT RUN CONSUMPTION IS CONSTANT SO TO INCREASE EMPLOYMENT NECESSARY TO MAKE INVESTMENT.
2. POSSIBILITY OF GENERAL OVER PRODUCTION AND UNEMPLOYMENT:AS MPC IS LESS THAN ONE SO THERS IS POSSIBILITY OF GENERAL OVER PRODUCTION
3. REFUTATION OF SAY’S LAW:- AS SAY’S LAW STATES THAT SUPPLY CREATES ITS OWN DEMAND. BUT AS MPC IS LESS THAN ONE SO IT IS NOT NECESSARY THAT AS=AD
4. DECLINE IN MEC:-DEFICIENCY OF AD COMPELS PRODUCERS TO SELL THEIR UNSOLD PRODUCTS AT LOW PRICE AND IT WILL REDUCE THE PROFITABILITY AND ALSO LEADS TO MARGINAL EFFICIENCY OF CAPITAL

5. UNDER EMPLOYMENT EQUILIBRIUM: UNDER EMPLOYMENT EQUILIBRIUM REFERS TO THAT SITUATION IN WHICH AGGREGATE DEMAND BECOMES EQUAL TO AS BEFORE REACHING FULL EMPLOYMENT LEVEL. IT IS BECAUSE OF FALL IN AGGREGATE OF DEMAND IS CAUSED BY FALL IN INVESTMENT DUE TO FALL IN MARGINAL EFFICIENCY OF CAPITAL AND CONSUMPTION DOES NOT INCREASE IN THE SAME RATIO AS INCOME DOES
6. OVER SAVING GAP IN ADVANCED ECONOMY:_ ON ACCOUNT OF EXCESSIVE INCREASE IN SAVING AGGREGATE DEMAND FALLS SHORT OF AGGREGATE SUPPLY. EXCESSIVE SAVING LEADS TO DEPRESSION AND UNEMPLOYMENT.
7. PEAKS AND TROUGHS OF TRADE CYCLE:- WHEN A TRADE CYCLE REACHES AT PEAK THE INCOME IS MAXIMUM BUT CONSUMPTION LAGS BEHIND. DEMAND FALLS AND IT STARTS TAKING DOWNWARD TREND. BUT WHEN IT REACHES A LIMIT PEOPLE DO BEST TO MAINTAIN THEIR PREVIOUS STANDARD OF LIVING SO RECOVERY PHASE STARTS

8. SECULAR STAGNATION:- ACCORDING TO THIS LAW CONSUMPTION EXPENDITURE INCREASES LESS THAN INCREASE IN INCOME. SO SAVING ACCUMULATES AND THERE IS TIME WHEN THE ENTREPRENEUR DO NOT FIND ENOUGH OPPORTUNITIES TO INVEST LARGE SAVING. ECONOMY REACHES THE SATURATION POINT. EMPLOYMENT CAN NOT BE MAINTAINED.
9. STATE INTERVENTION: IT BECOMES COMPULSORY IN THE EVENT OF DEPRESSION OR BOOM
10. UNIQUE PROCESS OF INCOME GENERATION:-AN INITIAL INVESTMENT IN THE ECONOMY RESULTS INTO INCREASE IN INCOME WHICH IS MANY MORE TIMES INCREASE THAN INVESTMENT THAT IS CALLED MULTIPLIER, MULTIPLIER IS BASED  ON MPC. HIGHER THE MPC AND HIGHER THE SIZE OF MULTIPLIER. BUT BECAUSE OF LEAKAGES INCOME DOES NOT INCREASE SO INCREASE AS COULD BE
11. INDUCED TO INVEST:AS THE MPC IS UNDER DEVELOP NATION IS MORE SO OPPORTUNITIES EXIST FOR ENOUGH INVESTMENT.

12. WAGES AND EMPLOYMENT: CLASSICAL ECONOMISTS EMPLOYMENT CAN BE INCREASED BY REDUCING BY MONEY WAGES BUT IT IS CRITICIZED BY KEYNES  BECAUSE REDUCTION IN IN MONEY WAGES WILL CAUSE REDUCTION IN INCOME OF POOR PEOPLE AND RISE IN RICH PEOPLE SO DEMAND WILL FALL. AS MPC OF POOR IS MORE THAN RICH SO AD WILL BE LESS AND OUTPUT AND EMPLOYMENT WILL FALL.