The Psychological Law of Consumption is one of the fundamental concepts in Keynesian economics. It was introduced by John Maynard Keynes to explain the relationship between income and consumption. According to this law, as income increases, consumption also increases, but not in the same proportion.
Keynes stated that “men are disposed, as a rule and on average, to increase their consumption as their income increases, but not by as much as the increase in income.”
According to this law, when income increases, people tend to spend a part of the increased income on consumption and save the remaining part. This means that consumption rises with income, but at a decreasing rate.
The proportion of additional income spent on consumption is called the marginal propensity to consume (MPC), which is always less than one. This implies that a part of income is always saved.
At low levels of income, most of the income is spent on basic needs, and savings are very small. As income increases, the proportion of income spent on consumption decreases, and savings increase.
Thus, the law highlights that consumption is a stable function of income and plays a crucial role in determining aggregate demand.
Consumption curve lies below 45° line showing MPC less than 1
The Psychological Law of Consumption explains how consumption changes with income and highlights the importance of saving. It is a key concept in Keynesian economics and plays a crucial role in determining aggregate demand and employment. Despite its limitations, it remains highly significant in economic analysis.