Impact of Income Distribution on Aggregate Consumption

Abstract

There is controversy about the main determinant of consumption behavior and the role of income distribution on aggregate consumption. Keynesian consider current income as the main determinant and income distribution as relevant, whereas Classicals consider interest rate as the main determinant and income distribution as irrelevant. Keynesian believe that marginal propensity to consume (mpc) is less than average propensity to consume (apc) and apc declines as income increases. Therefore, in a growing economy, the proportion of consumption in aggregate demand must fall. Consequently, economic activity may stagnate if there is no compensating increase in other components of aggregate demand. However, time series data testifies to a constant apc. In this paper, Keynesian consumption function is tested using cross-sectional micro data of Pakistan economy. The results confirm Keynesian view that rich people have lower marginal propensity to consume than poor people. The paper concludes that constancy of long run apc may be due to increase in household debt and household wealth which also influence consumption positively. Therefore, a suitable income redistribution scheme is advisable to control any possibility of economic stagnation and to ameliorate the problem of cascading household debt