Answer to Question #144921 in Macroeconomics for Anonymous

Question

What are the findings of Simon Kuznets about consumption and income? Explain how are these findings explained by different consumption theories?

Answer 1

The consumption function John. Keynes was an immediate success, but two problems soon arose. Both related to Keynes ' assumption that the average propensity to consume falls as income declines.

The first problem was found in connection with the forecasts that some economists made during the second world war. Based on Keynes ' consumption function, these economists stated that as income increases in the economy over time, families will consume less and less of it.

The second problem arose from new data on consumption and income Dating back to 1869. This data was collected in 1940 by economist Simon Kuznets, who later won the Nobel prize for this work. Kuznets discovered that the ratio of consumption to income was perfectly stable from decade to decade, despite a significant increase in income during the period he studied. Again, Keynes's assumption that the average propensity to consume decreases as income increases was not supported by the facts.

It turned out that in the long term, the marginal propensity to consume and the average propensity to consume are equal.

This phenomenon has been called the "riddle of Kuznets" in the economic literature.

Further research on the consumption function was devoted to the explanation of The "riddle of Kuznets". They were based on the time factor. The greatest success was achieved by American economists, future Nobel prize laureates. Modigliani, who created the life cycle theory, and M. Friedman, who developed the concept of permanent income. Both concepts are based on the theory of intertemporal choice of the famous American economist I. Fischer, in which consumer behavior is analyzed from the standpoint of microeconomic analysis.

Life cycle theory: if the ratio of wealth to disposable income is constant, that is, if disposable income and wealth change in the same proportion, then the average propensity to consume is constant, which is more typical for a long-term period.

In the short run, the ratio of wealth to disposable income is subject to strong change, which is the basis for the fluctuation in the average propensity to consume in the short run.

From the point of view of the theory of constant income: if the current income is more than constant, then the average propensity to consume temporarily falls. But these are only short-term fluctuations; in the long run, the average propensity to consume is constant, since in the long run, the current income and the constant income are likely to coincide.

It is the short and long term that have changed the understanding of the average propensity to consume and income.