Determinant of Consumption and Factors of Consumption Function

There are two groups of determinant of consumption factors that affect consumption function.

1. Subjective or internal factors: These are related to psychological characteristics of human wants. These factors change more in long run rather than short run. These factors are,

a. Precaution motive Every individual has a strong feeling to prepare for unseen emergencies like sickness, accident, unemployment etc. So they build up reserves for such emergencies.

b. Foresight motive Every man has future needs. They need to save for old age, educational needs of children, marriages of daughters etc.

c. Motive for independence Most of use have a strong desire to be independent financially. So we tend to save by sacrificing present consumption.

d. Standard of living We always want to improve the standard of living for which we reduce the consumption and save for future.

e. Status Motive People feel socially upgraded if they are financially strong. More wealth means higher status or pride.

2. Objective or External factors: a. Distribution of income This is an important factor of propensity to consume. The more inequality in income distribution, the lower will be the propensity to consume. Equal distribution of income increases the propensity to consume. Poor people have higher MPC, as their basic or primary needs are not satisfied. So, increase in income tends to increase MPC, whereas rich people have lower MPC.

b. Expectations Every consumer has certain calculations about their future changes. This may be regarding the price, income or employment. When they expect price increase in the future, they tend to consume immediately, or if they expect unemployment in future, they tend to consume less and save more.

c. Windfall gains or losses When the consumers get huge profit, they tend to consume more as income increases. However, loss will make them consume less due to decrease in income.

d. Fiscal policies Fiscal policy is related to tax structure and government expenditure. When the taxes are decreased the disposable income with people with increase and so will the consumption and vice versa.

e. Stock of wealth If any individual has enough stock of wealth in the form of bonds, fixed deposits etc., he tends to consume more from his current income. But if the stock of wealth is low, the individual will spend less and tend to save more