The factors which determine the level of consumption is called determinants of consumption. J.M. Keynes mentions two principal factors which influence the consumption function and determine its nature (slope) and position. They are: subjective factors, and objective factors.
- Subjective Features:
The subjective factors affecting propensity to consume consists of those psychological motives. Therefore, subjective factors are also known as psychological factors because these are internal factors that determine the consumption function. These factors are related to human behaviour and habits, social customs and traditions. There are different motives of consumers, which lead to determine the level of consumption.
(i) Demonstration motives:
If consumers are influenced by the consumption of other people and try to adopt similar consumption practices, such practices are known as demonstration effect. If the people of a country are affected by the demonstration effect, then the propensity to consume will be high and if not affected by the demonstration effect, then the propensity to consume will be low. Advertisement, fashion, luxurious life style, etc. are able to influence consumption pattern of the people.
(ii) Security motives:
The families and individuals in the modern industrialised societies are highly conscious with old age, sickness and other unforeseen contingencies related to economic insecurity. Hence, people try to save quite regularly. Such savings reduce the consumption function.
(iii) Business motives:
Business motive is one of the most important factors determining consumption function. Due to business motives the individuals and government cut down their current consumption. The business motive mainly influences the propensity to save of corporations and various business units. The uncertainty regarding the future, the quantity and quality of existing equipments, and other conditions give rise to motive for withholding a part of current earning which, in turn, reduces the consumption function.
(iv) Improvement and Development motive:
Improvement and development motives of the country and individuals also influence the pattern of consumption function. If the people would like to develop and improve their life and society, then they are ready to sacrifice a part of their present consumption. Therefore, improvement motive is one of effective factors to determine consumption function.
- Objective Factors:
Important objective factors which cause changes in the nature, shape and position of consumption are as follows:
Income is the most important factor that determines a community’s propensity to consume. As its income rises or falls, consumption also rises and falls.
(ii) Distribution of income:
Another factor determining how much will be spent for consumption out of a given income of the community is the way in which income is distributed. There is great inequality in the distribution of income in the modern capitalist societies with the result that the rich find it easy to save. This widespread inequality of income lowers the overall propensity to consume as the rich have already fulfilled most of their basic wants. A more equal distribution of wealth will raise the propensity to consume.
(iii) Fiscal Policy:
The fiscal policy of government relating to taxation, expenditure and public debt have significant effects on the consumption function. The Government’s fiscal policy resulting in highly progressive tax system brings about more equitable distribution of income which increases propensity to consume. On the other hand, a regressing tax structure will reduce total consumption in the economy.
(iv) Windfall Gains or Losses:
Sudden and unexpected gains and losses in income affect consumption accordingly. If windfall gains increases unexpectedly, then consumption will also increases and if losses increases, then propensity to consume will decrease. In the late twenties, there were huge windfall gains on account of the boom conditions in the American economy and consumption function shifted upwards.
(v) Changes in the rate of interest:
Changes in the rate of interest may also alter the propensity to consume though the direction of change is not certain. If the rate of interest goes up, people will consume less and save more in order to gain from lending on the higher rate of interest. On the other hand, people may consume more and save less with a fall in the rate of interest. Further, a person who desires a fixed income in future is likely to save less at a higher rate of interest than at a lower rate of interest.
(vi) Financial policies of corporations:
The policies of joint stock companies and corporations with respect to dividend payments and investment also affect consumption in various ways. If corporations and companies keep more reserves and distribute less of their profits as dividends, it will lower the disposable income with consumers. On the other hand, if more income is distributed in the form of dividends more will be spend on consumption.