Importance of the Psychological Law of Consumption

Importance of the Psychological Law of Consumption. Some implications of Keynes's Psychological Law of Consumption may be noted.

Importance of the Psychological Law of Consumption

Some implications of Keynes's Psychological Law of Consumption may be noted.

1. Crucial Importance of Investment. One implication is that since consumption largely is correlated to the revenue and consumption function is pretty consistent, it is essential to boost investment to fill up the space of decreasing consumption as revenue amplifies. If this step is not taken, improved output will not be cost-effective. This law, therefore, underlines the crucial importance of investment.

2. Possibility of Overproduction. This law states that even when income increases, consumption lags behind. Hence, general over-production is possible. The government will have to march in to cure the circumstances. The strategy of laissez-faire will not do. If somehow consumption is not improved, MEC will go down. The demand for investment will weaken and all economic development will come to hold.

3. Explains Turning Points of the Trade Cycle. Keynes's Law clarifies the turning points in a trade cycle. When the business cycle has accomplished the maximum affluence, revenue has gone up. But because consumption does not equally go up, the downhill cycle begins, for demand has been left behind. Similarly when the trade cycle has reached the lowest point, the business cycle begins growing, since consumption cannot be reduced past a certain limit. This is owing to the steadiness of marginal propensity to consume.

4. Explains Over-saving Gap. Besides, this law elaborates the over saving gap. As revenue keeps rising, consumption does not amplify as much since the marginal propensity to consume is less than unity. Hence, saving process progresses cumulatively and there starts the risk of over-saving.

5. Explains the Nature of Income-generation. Keynes's law also clarifies' the distinctive character of revenue generation. If money is infused into the financial system, it will boost consumption, but to a lesser degree than boost in revenue. This again is owing to the reality that consumption does not amplify along with boost in revenue.

The government can infuse money into the economy in different ways. One way is to create jobs by infusing money into projects like infrastructure. This has been proposed during the last two administrations in the United States, and called it shovel ready jobs. Yet, it did not seem to help the economy much, or it can take years to see the benefits.

Another way government can infuse money into the economy is to either give tax rebates or tax breaks to the public. This can increase consumer buying, but many times, this money goes to pay off debt or into savings accounts instead of boosting the economy.

Summing up, we can say that since marginal propensity to consume is less than unity, it brings out (a) the crucial importance of investment (b) possibility of general over-production, (c) declining tendency of the marginal efficiency of capital, (d) turning points of business cycle, (e) danger of over-saving, and (f) the unique nature of income generation.

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