Before that great depression of 1930’s, most economists established relationship between consumption (saving) and rate of interest. It was Keynes who, for the first time, explained that consumption depends upon disposable money income. He argued that consumption increases as disposable income increases but by an amount less than increase  in income. According to Keynes, “men are disposed, as a rule and on an average, to increase their income. “ In brief, consumption increases in a lesser proportion than increase in disposable income. This is called that ‘psychological law of consumption.

The psychological law of consumption consists of the following propositions:

(1)    When aggregate income increases, consumption expenditure also increases but by a somewhat smaller amount. The reason is that as income increases, more and more of our wants get satisfied, and therefore, lesser and lesser amounts are spent out of subsequent increases in income.

(2)    When income increases, the increment of income will be divided in certain proportion between consumption spending and saving. That part of the disposable income which is not spent on consumption constitutes saving.

(3)    As income increases both consumption spending and saving spending will go up. An increment in income is unlikely to lead either to less saving for less spending than before.

Keynes Psychological Law of Consumption is based upon the following assumption:

(i)    People’s habits regarding spending do not change in the short-run, i.e., propensity to consume remains unchanged. This assumption implies that only the income changes, whereas other factors such as distribution of income, prices, population etc., remain unchanged.

(ii)    The economy works under normal conditions, i.e., it is free from economic fluctuations like inflation and deflation.

(iii)    The law operates in a market oriented economy, i.e., there are no interventions by the state in the economic activates.

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