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Theoretical basis of the institutional explanation of the consumption function

Theoretical basis of the institutional explanation of the consumption function
Eigazaryan Margarita, associate professor, candidate of economics

Martirosyan Arman Ruben, associate professor, candidate of economics, doctoral candidate

Yerevan State University, Armenia

Championship participant: the National Research Analytics Championship - "Armenia";

the Open European-Asian Research Analytics Championship;

 

The article analyzes the problems of consumption volumes in different stages of economic development from institutional point of view. Ideas about consumption propensity over time are reviewed, overvalued, supplemented in the course of time alongside with other approaches. Economists believe that the changes in average propensity to consume could be expected by the influence of institutional factors.

Keywords: Consumption, psychological factor, household incomes, consumption expenditures, disposable income, average propensity to consume, marginal propensity to consume, consumption function, linear dependence.

 

The volume of consumption is of great importance in the economy and determines the volumes of production, rates of economic growth and development. Sometimes ideas about consumption propensity over time are reviewed, overvalued, supplemented in the course of time alongside with other approaches.

Even theorists, who accept that the consumption propensity is a constant value, do not deny that it can be changed over time. Particularly, in 1929-1941 propensity to consume was 0.73 in the USA, in 1970-ies it was 0.64 in GFR, and in 1990-ies it was 0.62 in Russia.[1]  According to the institutionalists it is the product of the institutional differences between countries. More output of time was included in the researches of S. Kuznets. Particularly, propensity to consume strived to 0.86 for 1869-1938 in the USA. It arose more interest among the specialists towards the theory of Keynes. There were three possible versions among the cause- effect explanations: 1. the impact of the relative income, 2. permanent income value, 3. life cyclicity.

1.        According to D. Duisenberg, the consumption level includes the psychological factor  and it is determined alongside with the society development at the same time with competitive relations inside the social group in which high quality of life and the simulation tends are the cores.

2.        According to M. Freedman the household incomes are subjected to more and more fluctuations in comparison with expenses done by them. The consumption expenditures were observed through the factor dependence not at the level of the current income but at the average income. According to this idea when getting a maximum income in the certain period of time the household later also tries to build its consumption by adjusting it to the consumption level of the following income.

3.        At last the research of the Nobel Prize winner (1985) F. Modigliani is built on the principle that the level of the household expenditure depends not only on the current level of the income but also on the income level expected in the course of life.

Besides the economists believe that the changes in average propensity to consume could be expected by the influence of institutional factors.[2]

Thus, equilibrium in the economy is established by the interaction of various cause-effects factors as investments, propensities to consume and save. According to Keynes the classical “invisible hand” cannot provide equilibrium in economy in the case of full employment. 

Let us observe the consumption function in the linear dependence with the disposable income. C=CA+kYD

Picture 1

If: 0<YD< CA – n            1. If K=0 then C= CA

                                        2. If   K®¥, C coincides with the axis of the ordinate

                                        3. If ¥>K>0, then C> CA

                                        4. If -¥<K<0, then C< CA

In the next interval “CA” level is considered to be overcome”.

The rectilinear equation having K angular coefficient and passing through (CA-n;CA) point is the following:

C = K YD – K CA + K n + CA

When YD>CA – n                   1. If         -¥<K<0      then       C < CA

                                                                         2. If           0<K<1     then      C = kYD - KCA + K n + CA

In this case let us represent the coordinates of the consumption function and YD = C rectilinear intersection point. The latter actually corresponds to the “condition” of equilibrium provided in the theory of Keynes. For this reason the following equations system should be solved:

It proceeds from the equilibrium requirements that

C = YD;              C = (K n - KCA + CA) / (1 – K)

3.                       If     K=1         then       C= n + YD

4.                       If   ¥> K > 1    then  C = kYD - KCA + K n + CA

5.                       K ®¥    then the function graph determining the dependence of consumption from disposable income  is vertical to the disposable income axis:  YD = CA – n

In the Keynesian theory the tax burden relieve or the deficit financing of the government purchases was considered to be the way out in the case of minimum level of the consumption volume recorded in recession period.

In the CA Csegment, when the expansion period in the economy is observed, it was important to reduce the marginal utility of the money among the “rentier“ or the rich by means of wealth redistribution .

To maintain the economy at the full employment level CE and to avoid further negative situations it was necessary to increase the investments opportunities. As since in comparison with CA CE segment the households prefer to preserve financial resources in cash. Later on slowdown of business activities were observed.  In order to avoid all these it was necessary to increase the amount of money. In this case real interest rate would be reduced in the economy and broad member of the society would not be interested in keeping their savings in cash. In the result the C = CA + C(Y) curve was coming closer to Y=C curve as possible and an attempt was made to establish an equilibrium in the preferable highest segment in the intersection point for C = CA + C(Y) ¨ Y=C curves.

The consumption function could be expressed through non linear dependence from disposable income and in practice it could have the below mentioned form. Let us show the differences in consumption value in the case of the same disposable income through Keynes and classical explanations. According to the main psychological law of Keynes people are more inclined to increase the consumption along with the income increase although not with the same size with which the income increased.[3] In this regard it is remarkable that the human’s “psychology” is that in the case of income lower than cost of living the consumption will not exceed that value.

Picture 2.

Let us suppose that in the income interval CA – n the value of consumption will not increase continuously[4]  and will be equal to the autonomous consumption value of CA.

According to the classical theory in the case of FYD, JYD, KYD valuesof income the consumption will be CF, CJ, CK, and according to Keynes theory it will be CQF, CQJ, CQK. In accordance with the classical theory the income and the consumption values will be equal and according to the Keynes theory the consumption value will increase corresponding to the income increase.

In practice in terms of all the above mentioned values of income, the consumption could be equal to CA. When the income values approach the vital CA living cost value, the increase in consumption becomes evident.

For example: according to the Keynes theory in the case of HYD, CYA values of income, the consumption accordingly will be CQH, CQA and in some cases  the consumption may be CIH, CIA. The difference between the consumption value CQH, CQA and accordingly CIH, CIA value can be explained through slow paces of the economy “recovery”.

Finally, in some economic situations in some stages of economic growth and development, for example the difference between the consumption value CK and autonomous consumption value CA by percentage points could coincide with the difference of the consumption value C IH and the autonomous consumption value CA. Although in the first case the exceed of consumption over the income value is explained through decrease in savings, occurred depts, in the second case with the economy recovery,  increased volumes of credit and leasing transactions.

 

References:

  1. M. Mashkovski, “Macroeconomics”, Moscow, 2004, pg. 55-56
  2. Barr R., “Political Economy”, V 2 T. Moscow 1994, T. 2 pg. 420
  3. J.M. Keynes, The General Theory of Employment, Interest and Money. 2002, Book III The Propensity to Consume/ 


[1] M. Mashkovski, “Macroeconomics”, Moscow, 2004, pg. 55-56

[2] Barr R., “Political Economy”, V 2 T. Moscow 1994, T. 2 pg. 420

[3] J.M. Keynes, The General Theory of Employment, Interest and Money. 2002, First published, Macmillan Cambridge University Press, for Royal Economic Society in 1936; Book III The Propensity to Consume. http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch08.htm  

[4] As mentioned in the Keynes theory, see the same J.M. Keynes, The General Theory of Employment, Interest and Money. 2002, First published, Macmillan Cambridge University Press, for Royal Economic Society in 1936; Book III The Propensity to Consume. http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch08.htm:

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Your rating: None Average: 6.2 (17 votes)
Comments: 14

Vardanyan Gagik Ishkhan

Статья интересна и поучительна, заслуживающая должного внимания.

Vardanyan Gagik Ishkhan

Хорошая статья, заслуживающая должного внимания, поучительна.

Vardanyan Gagik Ishkhan

Good article. You "explain the problem" in different points of view. It's dificult to analyze practical aspects but I belive You can.

Романович Людмила Геннадьевна

Статья представляет интерес. Согласна с А.М. Выходцем, что в работе недостаточно данных для подтверждения ее элементов новизны. С уважением, Романович Л.Г.

Andrey Marenkov

хорошая, интересная статья, актуальная тема.

Vykhodets Aleksander Mihaylovich

Название работы в полной мере соотвествует ее содержанию. Авторы предлагаю новый механизм исслдедования, при этом, на основе теоретических разработок приводятся и некоторые экспериментальные данные. Последних для проверки новой теории явно недостаточно. Так, авторы не определили величину расхождений теории и парактики

ALONA ZHAROVA

Спасибо за интересный анализ по актуальной теме экономического развития. С пожеланием творческих успехов, Жарова Алёна.

Khachpanov Giya Viacheslavovich

Метафора "невидимая рука" предложенное А. Смитом. Опять словно курс лекций по экономической теории.

Gegamyan Mariam Araikovna

Очень интересная и актульная тематика. Для меня было очень познавательно. Особо хочу выделить наглядные графики и приведенные формулы. Спасибо Вам за статью. Моя оценка 10.

Korolev Evgenie Sergeevich

Хорошая статья, заслуживающая должного внимания со стороны научного сообщества. Аспекты, приводимые автором, позволяют по-новому взглянуть на выбранную автором проблему.

Stepanova Vera Vladimirovna

The author compares theoretical approaches to determinants of consumption. The authors' conception is distinguished to be complex but at the same time is absolutely new point of view. We wish You further scientific achievements. V.Stepanova

Tatyana Veselova

Материал изложен очень доступно. Статья интересна и поучительна. Спасибо.

Zarytska Nataliia Petrivna

The problems of consumption volumes in different stages of economic development are rather good considered by the author. It is interesting for me to read your article.

Asanova Natalia Aleksandrovna

Уважаемый автор, спасибо Вам за интересные подходы в вашей области. Дальнейших Вам научных успехов.
Comments: 14

Vardanyan Gagik Ishkhan

Статья интересна и поучительна, заслуживающая должного внимания.

Vardanyan Gagik Ishkhan

Хорошая статья, заслуживающая должного внимания, поучительна.

Vardanyan Gagik Ishkhan

Good article. You "explain the problem" in different points of view. It's dificult to analyze practical aspects but I belive You can.

Романович Людмила Геннадьевна

Статья представляет интерес. Согласна с А.М. Выходцем, что в работе недостаточно данных для подтверждения ее элементов новизны. С уважением, Романович Л.Г.

Andrey Marenkov

хорошая, интересная статья, актуальная тема.

Vykhodets Aleksander Mihaylovich

Название работы в полной мере соотвествует ее содержанию. Авторы предлагаю новый механизм исслдедования, при этом, на основе теоретических разработок приводятся и некоторые экспериментальные данные. Последних для проверки новой теории явно недостаточно. Так, авторы не определили величину расхождений теории и парактики

ALONA ZHAROVA

Спасибо за интересный анализ по актуальной теме экономического развития. С пожеланием творческих успехов, Жарова Алёна.

Khachpanov Giya Viacheslavovich

Метафора "невидимая рука" предложенное А. Смитом. Опять словно курс лекций по экономической теории.

Gegamyan Mariam Araikovna

Очень интересная и актульная тематика. Для меня было очень познавательно. Особо хочу выделить наглядные графики и приведенные формулы. Спасибо Вам за статью. Моя оценка 10.

Korolev Evgenie Sergeevich

Хорошая статья, заслуживающая должного внимания со стороны научного сообщества. Аспекты, приводимые автором, позволяют по-новому взглянуть на выбранную автором проблему.

Stepanova Vera Vladimirovna

The author compares theoretical approaches to determinants of consumption. The authors' conception is distinguished to be complex but at the same time is absolutely new point of view. We wish You further scientific achievements. V.Stepanova

Tatyana Veselova

Материал изложен очень доступно. Статья интересна и поучительна. Спасибо.

Zarytska Nataliia Petrivna

The problems of consumption volumes in different stages of economic development are rather good considered by the author. It is interesting for me to read your article.

Asanova Natalia Aleksandrovna

Уважаемый автор, спасибо Вам за интересные подходы в вашей области. Дальнейших Вам научных успехов.
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