Explain in detail the Consumption Function. What are the factors affecting the Consumption Factor

The consumption function in its simplest linear form is written as,

C = a + bY

Here, C represents the level of consumption.

‘a’ represents the level of autonomous consumption.

‘b’ reflects the marginal propensity to consume and Y is the income level.

Autonomous consumption can be defined as consumption levels that do not depend on the level of income. Autonomous consumption remains constant and does not change with the level of income. ‘bY’ together reflects induced investment which is affected by the level of income.

The marginal propensity to consume is a measure that reflects the quantitative change in consumption levels due to a change in the level of income. In other words, it shows the change in consumption due to a change in income levels. Marginal propensity to consume or MPC can be represented as

MPC = ΔC/ΔY

Here, ΔC represents a change in consumption and ΔY shows the change in income.

First of all, the income of the consumer is the most important factor which affects consumption. Consumption varies directly along with the level of income. An increase in the income level will cause an increase in consumption as well. However, the rate of increase may vary.

Secondly, the distribution of income also affects consumption. Unequal distribution of income lowers consumption levels as a large share of income remains in the hands of a few. An equal distribution of income usually increases consumption levels.

Thirdly, interest rates are also an important factor that affect the level of consumption. When interest rates are high, consumers will tend to save more rather than consuming. So, we can say that there is a negative relationship between consumption and interest rate.

Consumer expectations also play an important role in determining consumption. If consumers expect a price rise or shortage in the future, they will tend to purchase a certain good in a larger quantity than usual.

Lastly, the fiscal policies of the government also play a crucial role in the determination of income. A tax rise will reduce disposable income in the hand of the consumer thus reducing the level of consumption. Similarly, an increase in government spending will increase income levels thus increasing consumption.