Consumption function is an epoch making contribution to the tools of economic analysis analogous to but even more important than Marshall’s discovery of demand function. Discuss

ANS NO:-1

Consumption function can be defined as the relationship between consumption and income.

Consumption = f (income) or C = f(y)

Consumption expenditure increases with increase in income. But increase consumption is less than increase in income. Consumption does not increase at the same rate as the income does. It is due to psychological behaviour of the people.

“As the income of people rises, their consumption also rises. But the whole increase in income is not changed into consumption.A part of it is saved.”

In economics, the Hicks-Marshall laws of derived demand assert that, other things equal, the own-wage elasticity of demand for a category of labour is high under the following conditions:

When the price elasticity of demand for the product being produced is high (scale effect). So when final product demand is elastic, an increase in wages will lead to a large change in the quantity of the final product demanded affecting employment greatly.

When other factors of production can be easily substituted for the category of labour (substitution effect).

When the supply of other factors of production is highly elastic (that is, usage of other factors of production can be increased without substantially increasing their prices) (substitution effect). That is, employers cannot easily replace labour as doing so will lead to a large increase in other factor prices making it useless.

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Thus, in consumption function we came to know about consumption expenditure. But in Marshall’s discovery we studied about the demand function. So, in economics consumption function is much more better than Marshall’s discovery of demand function.

QUS NO:-2

If saving dropped sharply in the economy, what would be likely to happen to investment? Why?

ANS NO:-2

Investment is an addition to the capital stock. It is the thing that really makes our economy go and grow.Income that is not consumed by immediately buying goods and services is saved.The decision to save is linked directly to the decision to invest. If a nation is to devote a larger share of its production to investment, then it must devote a smaller share to consumption, all other things unchanged. And that requires people to save more. if saving falls below investment, it can lead to a growth of aggregate demand and an economic boom. In the long term if saving falls below investment it eventually reduces investment and detracts from future growth. Future growth is made possible by foregoing present consumption to increase investment.

Investment is affected by the interest rate; the negative relationship between investment and the interest rate is illustrated by the investment demand curve. The position of this curve is affected by expectations, the level of economic activity, the stock of capital, the price of capital, the prices of other factors, technology, and public policy.