A Keynesian Consumption Function:
In his famous 1936 book, A General Theory of Employment, Interest and Money, the noted British economist John Maynard Keynes proposed a theoretical relationship between income and personal consumption expenditures. Keynes argued that as income went up, consumption would rise by a smaller amount. This theoretical has been empirically tested many times since 1936.
Milton Friedman, former professor of economics at the University of Chicago and winner of the Nobel Prize in economics, collected extensive data on income and consumption in the United States over a long period of time. Shown below are 10 observations on annual levels of consumption and income used by Friedman in his study. Using these data, derive a consumption function under the assumption that there exists a linear relationship between consumption and income. Figures are in billions of dollars.
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Year Income Consumption ________________________________________________________________
1 284.8 191.0
2 328.4 206.3
3 345.5 216.7
4 364.6 230.0
5 364.8 236.5
6 398.0 254.4
7 419.2 266.7
8 441.1 281.4
9 447.3 290.1
10 483.7 311.2
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Determine the dependent and independent variable and calculate a consumption factor. Establish the relationship between income and consumption and interpret. Discuss the fit of the data and explain.
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