Real and money consumption as functions of money income
Folsom, Roger Nils
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Most presentations of the “standard” Keynesian macroeconomic model include a consumption function in which real (deflated¹) consumption expenditure is a function of real income. Such a function assumes that a rise in output prices (and thus in the money value of income) does not affect aggregate real consumer demand, unless the price rise changes aggregate real output and real national income.² Thus validity for a consumption function written in real terms requires that money illusion not affect aggregate real consumption, and that changes in the structure of relative prices either not accompany price level changes or else not affect aggregate real consumption (either through substitution or income effects). Of course, a consumption function written in real terms can be restated in money terms, without abandoning the basic hypothesis that real consumption is independent of the price level.³ Although such a conversion is unquestionably valid formally, what are its implications? To answer that question, this note derives and discusses some properties of two alternative formulations of the consumption relationship: real consumption as a function of money income, and money consumption as a function of the price level. It concludes by discussing the graphical implications of these results.
The article of record as published may be found at http://dx.doi.org/10.1111/j.1465-7295.1969.tb01467.xA longer version of this note, including an introductory discussion using elementary linear functions and their graphs, is available under the same title, as Naval Postgraduate School Technical Report NPS-62FL9031A.
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