Absolute income hypothesis
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This document outlines the Absolute Income Hypothesis theory presented by Keynes in 1936. The theory states that as absolute income increases, the proportion of that income spent on consumption decreases. So while consumption increases with more income, the rate of increase declines. Key points include consumption (C) increasing at a decreasing rate as income (Y) rises, the average propensity to consume (APC) decreasing as income rises, and the theory showing consumption-income relationships in both the short run and long run.
Absolute income hypothesis
- 2. INTRODUCTION • THIS THEORY WAS PRESENTED BY KEYNESIAN IN 1936. • ACCORDING TO THIS THEORY “ AN INCREASE IN THE ABSOLUTE INCOME, THE FRACTION PROPORTION OF THAT INCOME DECREASES WHICH IS DENOTED TO CONSUMPTION” IN SIMPLE WORDS: “ AN INCREASE IN INCOME CONSUMPTION ALSO INCREASE BUT AT DECREASING RATE” IMPORTANT FEATURE ABOUT THIS THEORY IS THAT AN INCOME INCREASES THE APC DECREASES THROUGHOUT.
- 3. IMPORTANT ABBREVIATIONS • Y=INCOME • S=SAVINGS , S=Y-C • C=CONSUMPTION • APC= AVERAGE PROPENSITY TO CONSUME APC= C/Y • MPC=MARGINAL PROPENSITY TO CONSUME MPC=∆C/∆Y
- 4. TABLE OF THE THEORY Y C APC 2000 2400 1.2 4000 4000 1.0 6000 5400 0.9
- 5. GRAPHICAL PRESENTATION 0 2000 4000 6000 8000 Category 1 Category 2 Category 3 consumption income Chart Title Series 1 Series 2 Series 3
- 6. SHORT RUN • SHORT RUN CONSUMPTION FUNCTION SOWS NON PROPORTIONAL RELATIONSHIP BETWEEN INCOME AND CONSUMPTION. • IT MEANS THAT INCOME INCREASES CONSUMPTION ALSO INCREASES AT DECREASING RATE. 0 5000 10000 15000 20000 Category 1 Category 2 Category 3 consumption income Chart Title Series 1 Series 2
- 7. LONG RUN • IN THE LONG RUN, IT IS THE INDUCED CONSUMPTION WHICH TELLS US THE BEHAVIOR OF THE CONSUMPTION OF THE PEOPLE. 0 2000 4000 6000 8000 Category 1 Category 2 Category 3 consumption income Chart Title Series 1 Series 2 Column1