Understanding Marginal Propensity to Consume

Understanding Marginal Propensity to Consume August 30, 2011

The basic Keynesian model centers on consumption.  Before I go further, the Keynesian model is based on the works of John Maynard Keynes, an economist of the 20th century whose writings were very influential in shaping the economic framework that has been applied for the last half century.  You can read more about Keynes here and here.

What is Consumption?

In its very basic definition, consumption is the total spending on consumer goods over a period of time (generally a year).  Keynes’ basic assumption about consumption spending is this:

  1. Consumers base their spending primarily on their current take-home pay; that is, their disposable income.
  2. Consumers don’t spend all their additional income (we touched on this with the article about marginal propensity to save)

It’s no shocking statement, but when income goes up, so does spending according to the Keynesian model.  Can you attest to this?  We would call it increasing your standard of living.  When you make a little more, you will often spend a little more.  This is called the marginal propensity to consume.

Marginal Propensity to Consume MPC

The additional consumption caused from an extra dollar of income is equal to the marginal propensity to consume.  For example: If you earn an extra $10 this week and decide to ‘reward yourself’ by spending $5 on ice cream that you otherwise wouldn’t have bought, your MPC is .5 or 50%.

Combing the ideas of Marginal Propensity to Save and marginal propensity to consume, you have this;

MPC + MPS = 1.  This makes sense because for every dollar that is added to your income, you’ll either save or spend it.  Yes, it’s elementary, but the most fundamental components of economics aren’t too terribly hard to understand…but they are difficult to keep.

Have you ever thought about your marginal propensity to consume?  Think about it for a while.  If you get an extra dollar (or hundred) where does your mind go…savings…or consuming?

 

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