Question

What are the assumptions of the Keynesian Model?

What is the Consumption Function and what causes shifts in the Consumption Function?

Answer 1

The assumptions of the Keynesian Model are:

1. Demand creates its own supply.
2. The aggregate price level remains fixed. This means that all variables are real variables and all changes are in real terms. Therefore if aggregate demand increases, output will increase, prices remaining the same. And due to the existence of excess production capacity and unemployed resources the economy will reach the point of full employment - if there is sufficient demand stimulation.
3. The economy has excess production capacity.
4. The economy is closed i.e, there is no export and import.
5. There is no retained earnings. All profits are assumed to be distributed as dividends among the shareholders.
6. Firms are assumed to make no tax payments; all taxes are paid by households.

Consumption Function:

In economics, the Consumption Function describes a relationship between consumption and disposable income.

The factors that causes shift in the consumption function are:

1. The Rate of Interest.
2. Sales Effort.
3. The Volume of Wealth.
4. Terms of Consumer Credit.
5. Deferred Payment.
6. Psychological Factors.
7. Structural Factors.
8. Fiscal Policy.