Question

What were Keynes’s three conjectures about the consumption function? Describe the evidence that was consistent with Keynes’s conjectures and the evidence that was inconsistent with them.

Answer 1

3 conjuctures :

1) MPC is between zero & one.

2) as income rise,APC - average propensity to consume, falls.

As income rise,people tend to save more.

3) income is primary determinant of consumption.& Interest rate doesn't play important role.

So C = A + MPC*Y

A is autonomous Consumption.

evidence to support:

aggregate data on consumption and income for the period between the two world wars, supported the Keynesian consumption function.

Periods of low income, like during the depths of the Great Depression, both consumption and saving were low, indicating that the MPC is between zero and one.

Also during those years of low income, the ratio of consumption to income was high, confirming Keynes’s second conjecture. Y falls,APC rise.

The strong correlation between the Consumption & income , left no other variable to important for explaining the Consumption., Proving third conjecture

evidence that was inconsistent :

1) Keynes related consumption to current income.but while making saving- Consumption decisions,people consider both present & future.

Thus to enjoy more consumption,they have to give up tomorrow's Consumption .

Thus Consumption patterns depend upon future income too.

So Keynes overlooked rationality & forward looking behaviour.

2) in long run, APC is fairly constant. As proved by Simon Kuznets.

Thus 2 nd conjucture holds only for short run data.