What are the Factors which Influence the Consumption Demand?

As is evident from the definition of the consumption function, consumption expenditure is a stable function of income. The fact is also supported by statistical evidence. The data on consumption expenditure and income from all over the world testify the stability of the relationship between the two.

Nevertheless, factors other than income cannot be overlooked as insignificant in respect of their influence on the consumption expenditure. Keynes himself has observed in his General Theory, “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, and

3. Partly on the other subjective needs of the psychological propensities and habits of the individuals composing it and the principle on which the income is divided between them.”

In general, the factors influencing consumption demand may be summarised below:

1. Income:

The consumption expenditure, as seen earlier, is a function of income. It varies directly with income of the consumers. The higher the income, the higher the consumption expenditure except at sufficiently high levels of income at which the consumption expenditure reaches a saturation point and even begins to decline beyond it. Exceptional behaviour of the consumption expenditure is witnessed in advanced countries or among the rich when consumers attain desired level of standard of living.

2. The Objective Factors:

Among the objective factors are the following ones:

(a) Distribution of Income:

National income remaining the same, consumption expenditure would depend on how national income is distributed among the consumers in a nation. People with smaller incomes spend everything on consumer goods.

Their income levels are either below the levels of subsistence or at par with it. On the contrary, the rich enjoy incomes much higher than their desired levels of consumption. The rich, therefore, do not spend whole of their income on consumption.

Despite their wasteful expenditures, the rich are able to save a lot. If a redistribution of income takes place so that the income-surplus with the rich is equitably distributed among the poorer sections of the community, the aggregate consumption expenditure would certainly increase and the level of savings would significantly fall.

Income distribution, thus, has a significant role to play in influencing the magnitude of the consumption expenditure. Also, it is easy to observe that the inequality of income distribution is must for the accumulation of savings which are so essential for financing the investment.

(b) Stock of Wealth:

Wealth is accumulated by the people either to provide against the uncertainties of life or to help meet some expenditure in future or even for the purpose of demonstration. Successive units of wealth accumulated follow the law of diminishing marginal utility.

As a result, the desire for additional units of wealth, at certain level of its stock, is overtaken by the desire for enjoying current consumption. The consumption expenditure continues to be low until the desired stock of wealth is accumulated and it begins to increase thereafter. The argument, however, is based on Pigou’s model of consumer behaviour which was not supported by any empirical tests.

(c) Capital Gains:

Also known as windfall gains, the capital gains do not enter into the net income which is generally treated as the source of financing the consumption expenditure. Capital gains obviously constitute a significant component of the disposable income of the consumers.

J.M. Keynes recognized the fact and attributed the cause of the prolonged American boom of late twenties to the higher consumption expenditure sustained by a large volume of capital gains realized by the Americans in the stock markets. Most of the economists, except Jan Tinbergen, ignored capital gains as one of the sources of financing the consumption expenditure.

(d) Availability of Consumer Credit:

It is a common observation that a large number of the households procure credit facility to acquire consumer durables such as automobiles, TVs, refrigerators, etc. In absence of such credit facility, known as consumer-credit, the expenditure on the consumer durables would decline significantly as a sizable number of consumers lack cash to buy such items. Thus availability of the consumer credit has a significant bearing on the consumption expenditure.

(e) Rate of Interest:

According to classical economists, rate of interest is the sole determinant of the size of the savings. The higher the rate of interest, the higher the tendency among the people to save. Thus a rise in the rate of interest increases the volume of savings and hence decreases the consumption expenditure.

J.M. Keynes, however, rejected the classical contention and held that the volume of savings depends on the volume of income. A large number of economists are in agreement with Keynes but are not so certain about their convictions.

It is, nevertheless, true that borrowings for the purchase of consumer durables get discouraged at higher rates of interest. Equally true is the observation that higher rates of interest serve as an incentive to people to save for heavier returns on their savings.

The notion cannot, however, be applied uniformly on all the individuals. Some of them divide savings between current and future consumption. Quite a few empirical studies have, nevertheless, confirmed an inverse variation of consumption expenditure with the rate of interest.

3. Subjective Factors:

Subjective factors vary from individual to individual and are not quantifiable like the objective factors. J.M. Keynes identified certain motives that compel individuals to exercise restraints on their consumption expenditures. Some of them are mentioned below:

1. Motive of Precaution: To raise reserves against unforeseen contingencies.

2. Motive of Enterprise: To raise reserves for business or for speculation.

3. Motive of Avarice: To satisfy miserliness or inhibitions against acts of expenditure.

4. Motive of Pride: To bequeath a fortune.

5. Motive of Improvement: To enjoy gradually increasing expenditure for improving standard of living.

6. Motive of Independence: To acquire a sense of economic independence.

7. Motive of Calculation: To enjoy interest appreciation for larger real consumption at a later date.

8. Motive of Foresight: To provide for old-age, children’s education or for their marriage.

J.M. Keynes himself has called these motives as the motives of precaution, enterprise, avarice, pride, improvement, independence, calculation and foresight respectively. Motives for saving by the state, public sector and by the private sector corporations are, according to Keynes, the motives of enterprise, motives of liquidity, motives of improvement, and the motives of financial prudence.