The hypothesis implies that the tendency of propensity to consume shows progressive decline is its value at higher and higher levels of income. In other words MPC goes on falling in its value as level of income increase. Let’s illustrate this.

 As income increases from 100 to 200 the increase is 100 percent since the income has doubled. But consumption expenditure has increased from 80 to 150 and has less than doubled. Out of additional or marginal income of 100, the marginal propensity to consume reduces from 0.8 to 0.7 (150 80 = 70 100 = 0.7). Similarly for other values of Y and C, Keynes’ hypothesis about progressively falling value of MPC seems to be realistic. It is based on the fact that as level of income rises, basic and urgent wants having been already satisfied, additional consumption at additional income is likely to be smaller in proportion. This explains Keynes’ hypothesis that as level of income rises (100,200, 500 etc.) consumption expenditure will increase absolutely (C = 80, 150, 350 etc.), but will fall relatively (MPC = 0.8, 0.7 etc.).

The effect of consumption behavior has far reaching consequences. Since 'C' is an important component of the effective demand, a progressive fall in its relative value cause a widening gap between 'Y' and 'C' (20,50,150…). This is a source of the deficiency in the effective demand and hence a cause of unemployment.

(E) Multiplier: Before we proceed with the derivation of the multiplier let’s briefly present Keynes’ views about savings behavior.

i) Propensity to save: For Keynes, savings is simply non-consumption. It is a negative activity. That portion of the income which remains unconsumed is automatically saved. Therefore there is no propensity to save as such. This will be clear with the help of Keynes’ equation of expenditure. Just as the equation of income :

Y = C + I

We have the equation of expenditure:

Y = C + S or rather,

S = Y C

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Index

5. 1 Classical Theory
5. 2 Keynes' Employment Theory

Chapter 6