Page 102 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 5: Consumption Function

Figure 5.6 Notes

Duesenberry's explanation has some obvious appeal and appears to capture some elements of
the psychological behaviours of consumers. It is easier to adjust consumption habits while the
level of income is rising and it is not unrealistic to assume that these habits are formed through
emulation and the desire for social acceptance and approval. Moreover, income declines do pose
problems for consumers and the hypothesised behaviour that they tend to retain the old habits
for as long as possible is quite plausible. Thus, Duesenberry's introduction of socio-psychological
motivations makes his consumption theory more impressive than the simple Keynesian absolute
income hypothesis.
Other economists have also tried to reconcile the inconsistent empirical consumption functions
and their explanations too lead to the conclusion that the long run income-consumption relation
is more basic and stable, although their reasons differ somewhat from Duesenberry's. At least
three important alternative empirical studies on consumption function deserve discussion. They
are: permanent income hypothesis by Milton Friedman, life cycle income hypothesis by Albert
Ando, Franco Modigliani and Richard Brumberg and drift hypothesis by Arthur Smithies and
James Tobin.

Case Study India's Consumer Evolution

ndia is poised for a dramatic expansion of domestic consumption that will make the
country one of the largest consumer markets in the world. However, many voices in
Ithe country have expressed concern that this explosion of spending power will
compromise India's ability to invest for the future. New research by the McKinsey Global
Institute (MGI) finds that these fears are misplaced.

If overall economic growth remains on a long-term path of 7 to 8 percent, as most economists
expect, then consumption will soar. We estimate that real consumption will grow from
17 trillion Indian rupees today to 70 trillion Indian rupees by 2025, a fourfold increase.
This will vault India into the premier league among the world's consumer markets. Today
its consumer market ranks 12th. By 2015 it will be almost as large as Italy's market. By
2025, India's market will be the fifth largest in the world, surpassing Germany. In short,
we believe that India has now entered a virtuous long-term cycle in which rising incomes
lead to increasing consumption, which, in turn, creates more business opportunities and
employment, further fuelling GDP and income growth.
Contd...

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