Determinants Propensity To Consume

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The propensity to consume and save depend on both subjective and objective factors.These are influenced by the nature of people. If people are cautious about the safety and security for themselves, they will provide more for future contingencies and social obligations. Accordingly, the propensity to consume would be less. On the contrary, some people prefer to live lavishly and have high propensity to save. Tastes, habits, social status, family structure, demonstration effect, level of indebtedness, also affect the propensity to consume and save.Though income is the main determinant of the propensity to consume (or consumption), but, the influence of other factors cannot be ignored.

The principal objective factors which affect the propensity to consume are the following:

1.    Distribution of Income

The pattern of income distribution has a great influence on the propensity to consume. The propensity to consume is higher for people with low income. They spend almost everything they earn for their subsistence. Every additional rupee they get is used to satisfy their unfulfilled desires. In contrast, affluent people inspite of their extravagant wasteful expenditure are able to save a lot.

2.    Nature and Pattern of Income Receipt

 Stability in the income receipt enhances the propensity to consume. On the other hand, if a person is not certain about his income or the time of receipt, he will spend income with utmost care so as to save for the bad time. The method of receiving income also affects the propensity to consume. A number of compulsory deductions from the salaries for contributions to provident fund, social security schemes, insurance, etc., reduce the disposable income  of  people for the current consumption. Accordingly, the propensity to consume is adversely affected. The propensity to save will rise in such a case.

3.    Wealth

The amount of accumulated wealth has an important influence on the propensity to consume. The larger the wealth accumulated by a person, the lesser would be the utility from each successive addition to the existing stock of wealth on account of already acquired financial security. Therefor, an attempt to decrease current consumption to add to future wealth will diminish. Propensity to consume is, thus, higher with greater wealth. If people have nothing like that, they would spend less consumption.

4.    Consumer Credit

The cost and availability of the consumer credit affects the level of consumption expenditure on durables like automobiles, televisions, refrigerators, etc. The credit purchase entails interest cost, but, consumers still purchase more when installment credit is available. Installment credit induces replacement of durable consumer goods and discourages saving. In the absence of consumer credit or when its cost is very high, the demand for durable goods would decline substantially. In such situation, consumers will have to wait until sufficient funds are accumulated to purchase these goods.

5.    Stock of Consumer Durables

The stock of durables with the consumers affects their consumption expenditure. Possession of such goods will reduce demand. Further, possession of these durables will increase the demand for non-durable goods. For example, fruits, vegetables, milk, etc., are purchased more than what is presently needed so as to keep the refrigerator in full use. As a result, the consumption expenditure is increased.

6.    Availability of Goods

The availability of goods influences the level of consumption. When the goods are in  shortage, the people are forced to save. If on the other hand, some new goods are introduced,
the purchase of such goods will increase the consumption expenditure.

7.    Future Expectations

If war or an emergency is expected in the near future, people start hoarding goods anticipation of future shortage and rising prices. Consequently, propensity to consume rise. On the other hand, if prices are expected to fall in the future, people would buy only essential items. Accordingly, the propensity to consume will come down.

8.    Capital Gains

Capital gains or windfall gains have considerable impact on consumption spending. Such unexpected and sudden gains increase the net worth of the consumers. The American boom of late twenties created huge windfall gains, increasing the consumption spending. On the contrary, a sudden and unexpected loss would reduce the consumption.

9.    Price

Price is an important determinant of demand. A significant rise in the price of a commodity will substantially reduce its consumption and vice-versa, unless the elasticity of demand for the product is very low.

10.    Fiscal Policy

Changes in government’s fiscal policy, particularly taxation considerably affects the consumption expenditure. For instance, a reduction in direct taxes will leave more disposable income with the people. Accordingly, the level of consumption will arise at all levels of income. Further, a progressive tax policy leads to even distribution of income and hence raises the propensity to consume. On the contrary, a rise in the tax rates reduces the level of consumption. Similarly, indirect taxes on commodities raise their price and reduce the propensity to consume. Taxation policy is thus, more important for consumption expenditure than mere changes in prices. Further more, public expenditure on welfare programmes raises the propensity to consume.

11.    Rate of Interest

Prior to Keynes ‘ General Theory’, the rate of interest was considered the major determinant of saving and hence of consumption. It was believed that saving was directly related to the rate of interest. In other words, increase in the rate of interest induces savings and discourages consumption.

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