The cornerstone of Keynes’ General Theory is the so-called ‘fundamental psychological law’ concerning the propensity to consume:
P. 96: “The fundamental psychological law, upon which we are entitled to
depend with great confidence both a priori from our knowledge of human
nature and from the detailed facts of experience, is that men are disposed,
as a rule and on the average, to increase their consumption as their income
increases, but not by as much as the increase in their income.”
P. 97: “But, apart from short-period changes in the level of income, it is also
obvious that a higher absolute level of income will tend, as a rule, to
widen the gap between income and consumption. For the satisfaction of
the immediate primary needs of a man and his family is usually a stronger
motive than the motives towards accumulation, which only acquire
effective sway when a margin of comfort has been attained. These
reasons will lead, as a rule, to a greater proportion of income being saved
as real income increases. But whether or not a greater proportion is
saved, we take it as a fundamental psychological rule of any modern
community that, when its real income is increased, it will not increase its
consumption by an equal absolute amount, so that a greater absolute
amount must be saved, unless a large and unusual change is occurring at
the same time in other factors.”
Now, Keynes has stated that this is true both a priori and empirically. Is that so? Can any such law be deduced praxeologically? Is there any data to support it empirically? Hazlitt, in The Failure of the New Economics, provides some statistics to show that there is no such observed relationship. Does anyone have anything else on this?
Also, any other discussion on praxeological or empirical explanations for the determination of different time preferences is welcome.
No such law can be determined praxeologically, it is strictly unpraxeological, but I would say that Keynes isn’t really trying to establish a praxeological concept, insofar as he understands the concept, as indicated by the words “as a rule”, and while I would not be at all surprised if it were generally true after income reaches a certain point, however I can testify that in my recent experience where my income has fallen precipitously that I have started saving every f***ing penny. So I think that realistically this will apply itself in “tiers” of income. For myself it depends entirely upon how much my total income is and what becomes realistically available for me to consume at these various levels. At certain levels of income I’d save a high percentage, at others, a low percentage.
it doesnt make any sense at all. Why does he use the word ‘rule’? is he just avoiding putting any certainty in anything he writes?
In other words:
“The fundamental psychological law is that men are [kinda sorta inclined]
to increase their consumption as their income
increases, but not by [more than they actually make].”
how can he call it a FUNDAMENTAL LAW that is inclined to do something. Not much of a damn law.
I dont know a single middle income family that doesnt cut spending towards the end of their career to save for retirement (though i acknowledge im sure there are plenty of fiscally irresponsible people at there that do). This is also during the time where their wages are increasing the most and at their heights of their career (typically).
How can there be a law in spending behavior that is universal? its crazy talk.
-people’s time preference do change with a change in income, but to suggest there is a law in that is universal is crazy.
Thanks for the responses. As I thought, Keynes seems to simply create the supposed ‘law’ out of nothing. He relies on the belief that individuals have a certain absolute amount necessarily dedicated to consumption, so that at low income there will be a higher percentage of income going towards this consumption than at higher incomes, even if this total consumption somehow increases with higher income. But why cannot it not be the opposite case, i.e. that people have a certain absolute amount which they wish to save and that, achieving that, they prefer to consume the rest (resulting in greater total consumption when they have higher incomes)?
Also, I believe that the emphasis on this so-called ‘fundamental law’ is misplaced, since I have discovered a few reasons why the conclusions of The General Theory do not hold even assuming the veracity of this ‘law’.
I haven’t read The General Theory, but judging from that quote, Keynes doesn’t seem to be saying that people have a fixed amount dedicated to consumption and that the percentage of total income devoted to savings necessarily increases with increases in wealth. He seems to be pretty explicit that his main point is about the absolute level: “But whether or not a greater proportion is saved, we take it as a fundamental psychological rule of any modern community that, when its real income is increased, it will not increase its consumption by an equal absolute amount, so that a greater absolute amount must be saved, unless a large and unusual change is occurring at the same time in other factors.”
I take this to mean something like, if I receive a raise of $50, I’m going to increase my consumption by something less than $50.
I don’t think anyone here would disagree with that classification of what is being said, but there has been some disagreement raised over whether or not it’s necessarily true, although I think everyone here would agree that the MPC being a constant value is foolish.
I would like to throw out there that it is probably true in most situations, but indeed what the actual value is will vary a lot.
Whats funny to me is that this is supposed to be a “general rule” but it seems like the opposite is more of a general rule, as in somebody who lives paycheck to paycheck is gonna spend his whole paycheck, whether he gets a raise or not. And that has been observed to occur around these parts (Mars).
Did I say something to disagree with that? I might have said percentage where not necessary (though Keynes does note that he thinks the percentage of savings increases with income ‘as a rule’), but the focus was on the gap between saving and consumption.
There’s no decrease in ‘propensity to consume’: as Mises said, all saving is just delayed consumption. If anything, more savings could be considered exhibiting a greater propensity to consume, as if I can either spend $5 on an apple now, or save/invest it, increasing it to $10 in two years time and then spending that $10, obviously (inflation aside) saving it would allow for greater consumption on my part.
Hazlitt, The Failure of the New Economics pp. 112-113 (see also the pages that follow):
'Here is a table, taken from official statistics, showing the
disposable personal income in the United States for the
twelve years 1944 through 1955, inclusive; the amount of
personal savings in the same twelve years, and saving as a
percentage of disposable income:
Now let us see what these figures do to Keynes’s alleged
“psychological law.” The events of 1955 were in themselves
an emphatic contradiction. Disposable personal income increased
by $14.6 billion, but savings fell by $1.2 billion.
The total percentage of saving to disposable income fell
from 7.2 to 6.3. The same thing happened between 1953
and 1954. Disposable income went up $4.4 billion, savings
down $1.5 billion.’
I think the first thing Keynes would probably point out about those statistics is that they completely ignore government spending. If the UK were to privatize healthcare, the resulting decrease in taxation would mean an increase in disposable personal income. However, people would then have to purchase healthcare themselves. If the private healthcare costs more than the government healthcare that it replaces (which the Keynesian would assure you that it would), then consumers would indeed increase their consumption at a higher absolute level than their increase in income.
I haven’t been able to find a detailed source for government spending for those years. The best I’ve found is this graph:
This seems to support my hypothesis that changes in government spending account for the supposed divergences in Keynes “psychological law” (I do find this term a bit strange). During 1944 and 1945, government spending is higher, which corresponds to the high rate of savings. Many people were in the military during these years and had their food, shelter, and healthcare provided for them by the government. They also received a salary, which given that their consumption goods were provided to them directly, they were free to invest a larger portion. The point where government spending reaches its lowest (looks like about 1947) is also when personal savings is lowest. And in or just before 1955 where income increases and savings decrease–which Hazlitt says is an “emphatic contradiction” of Keynes–government spending takes a sharp drop.
I doubt Keynes would be foolish enough to think that government spending has no affect on the propensity to consume. In fact, if it didn’t, it would seem to undermine his prescriptive interventionist measures. Keynes is even explicit in the quote that he is talking about the “modern community” and not merely an aggregate of personal incomes. Surely government also takes in income and spends it on consumption.
What is your new avatar?
Immanuel Kant…I had thought. But now that I’ve Googled it, some sources say it’s Kant and some say it’s Friedrich Heinrich Jacobi. A mystery…
perhaps government spending should have been included in the “general rule” elsewise what good is it? If I tell you theres a general rule that martians eat chicken salad on fridays, and then you show me statistics on martian eating habits, and they actually eat porterhouse steak on fridays, would you consider it a cop-out if I replied that they ate the steaks at restaurants and so it doesnt count?
servicemembers pay for their food and shelter. They also oftentimes pay for their healthcare.