FACTORS AFFECTING CONSUMPTION FUNCTION
Factors affecting consumption function can be distinguished into two types objective factors and subjective factors.
A) OBJECTIVE FACTORS
1) Changes in income: A rise in real income leads to an increase in income. A rise in income increases consumption at a diminishing rate.
2) Changes in tax rate: Income received is subjected to income tax. A deduction of tax from total income is known as disposable income. A rise in tax rate will decrease disposable income which leads to a decrease in the consumption of citizens and vice versa.
3) Changes in interest rate: Changes in interest rates also affects consumption function. Interest rates affect the borrowing of citizens. A rise in interest rate will make borrowing more costly which will lead to a decrease in borrowing and a decrease in borrowing will lead to a decrease in consumption. Whereas a decrease in interest will increase borrowing and consumption.
4) Windfall loses and gains: A sudden gain and losses will affect consumption. As sudden gains will lead to an increase in consumption whereas sudden losses will decrease consumption.
B) SUBJECTIVE FACTORS
1) Motive of precautions: people keep some reserves of money to meet unforeseen contingencies like hospital bills, unemployment, etc.
2) Improvement in standard of living: To improve their standard of living people incur more expenses on luxury items, houses, cars, etc.
3) The motive of foresight: People save money for their life after retirement and invest that money in retirement funds or buy assets by reducing current consumption, so they can have a worry-free future.
4) The motive of avarice: Avarice means miser, avarice or miser person will not spend more irrespective of an increase in income.