The Propensity to Consume

The volume of employment is determined by the intersection of the aggregate supply function with the aggregate demand function.

• The aggregate supply function depends on the physical conditions of supply Chapter 20 will elaborate on the aggregate supply function and its inverse, “the employment function”.

The aggregate demand function has been overlooked.

• Books 3 and 4 deal with this.

The aggregate demand function is the relationship of any given level of employment to the “proceeds” which that level of employment is expected to realise.

The “proceeds” are made up of the sum of 2 quantities:

• the sum which will be spent on consumption when employment is at the given level, and
• the sum which will be devoted to investment.

The factors which govern these 2 quantities are largely distinct.

In this book, we shall consider what factors determine the sum which will be spent on consumption when employment is at a given level.

Book 4 shall consider the factors which determine the sum which will be devoted to investment.

Since we are here concerned in determining what sum will be spent on consumption when employment is at a given level, we should consider the function which relates the former quantity (C) to the latter (N).

It is more convenient to work with the function which relates the consumption per hourly-common-wage Cw to the income in terms of hourly-common-wage Yw that corresponds to a level of employment N.

Others object to this by saying that Yw is not a unique function of N, which is the same in all circumstances.

• The relationship between Yw and N might depend (probably in a very minor degree) on the precise nature of the employment.
• For example, 2 different distributions of a given aggregate employment N between different employments might (owing to the different shapes of the individual employment functions — a matter to be discussed in Chapter 20 below) lead to different values of Yw.

I answer that a special allowance might be made for this factor.

• But in general, it is a good approximation to regard Yw as uniquely determined by N.

The “propensity to consume” is the functional relationship χ between:

• Yw a given level of income in terms of hourly-common-wage, and
• Cw the expenditure on consumption out of that level of income

Cw = χ(Yw) or C = W.χ(Yw). 

The amount that the community spends on consumption obviously depends:

1. partly on the amount of its income
2. partly on the other objective attendant circumstances
3. partly on the subjective needs and the psychological propensities and habits of the individuals composing it and the principles on which the income is divided between them (which may suffer modification as output is increased).

The motives to spending interact and the attempt to classify them runs the danger of false division.

Nevertheless it will clear our minds to consider them separately under two broad heads which we shall call the subjective factors and the objective factors.

The subjective factors are:

• human psychology
• social practices and institutions

These are unlikely to undergo a material change over a short period of time except in abnormal or revolutionary circumstances.

In an historical enquiry or in comparing one social system with another of a different type, it is necessary to take account of the manner in which changes in the subjective factors may affect the propensity to consume.

But, in general, we shall in what follows take the subjective factors as given; and we shall assume that the propensity to consume depends only on changes in the objective factors.