Ratchet effect and Demonstration effect

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According to Dussenberry’s Relative income hypothesis, consumption function is not independent but is interdependent upon the relative position in the society. The consumption habits may change if the relative position of individuals changes in the society. It is explained through Ratchet effect and demonstration effects. Every man wants to imitate the higher standard of living of their neighbors. He wants to live up their Joneses. This is called as demonstration effect in consumption behavior. There is another influencing behavior in the consumption. When a man regards himself as equals to the neighbors, he was to express his superiority. Thus, when income level increases, the consumption level is likely to go up. 


Another feature of Dussenberry’s consumption function is that once the higher standard of living of the consumer is achieved, it cannot come down with the decrease in their income. This is called ratchet effect of consumption function. Under such conditions, a fall in income will not cause the proportionate fall in the consumption. Consumption will fall very slowly. The consumption normally remains the same as consumption standard of peak level of income. The ratchet effect is shown in the following figure. 



 


 


According to the above figure, when income rises from OY0 to OY1, consumption will increase along the path OCL. But when the income goes down to OY0 from OY1, the consumption will not follow OCL line but it will Fall very slowly along the line bb. Thus, when income increases, consumption will change rapidly whereas when income decreases, consumption will also rapidly diminish.


There may be some changes in the relative income position but in aggregate, it will be at balance. When the income grows steadily, MPC is always equal to APC and increase in consumption will be proportional to the increase in income as the consumer stay on the long run consumption function throughout the entire period of steady income growth. During the period of recession as the income goes down, APC goes up as the consumer moves backward on the short run consumption function. 


 


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