Impact of Marginal Propensity to Consume on Individual & National Economy

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  • 0:05 Marginal Propensity to Consume
  • 1:49 Effects on Individuals
  • 2:51 Effects on the Economy
  • 3:48 Lesson Summary
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Lesson Transcript
Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson, we will learn about marginal propensity to consume. We will learn what it is and how it affects both individuals as well as the economy. When the lesson concludes, you will be able to test your knowledge with a quiz.

Marginal Propensity to Consume

Most of us have a budget we follow after each paycheck. We often sit down and pay bills, and then decide what to do with any remaining money left over. Should we spend it on a new pair of shoes we have been eyeing for weeks? Or should we put it in the bank and save it? While this may be a reoccurring decision after each paycheck, what happens when we get a raise? Will we change our budget? What will happen to our spending habits? In this lesson, we will learn about marginal propensity to consume.

Let's take a moment to define this key term. Marginal propensity to consume is the term used to describe the amount of a raise in income that is spent on goods instead of saving that money. In other words, when we get an increase in pay, the amount we spend on goods rather than tucking it away and saving it is known as marginal propensity to consume.

To better explain the concept of marginal propensity to consume, let's apply it to an example. Imagine you get your December paycheck and realize you received a Christmas bonus. Instead of getting paid $1,300, you see that you have been paid $1,600. This means you have an extra $300 more than you previously had. If you decide to spend $200 on that new pair of shoes you have been eyeing and place the other $100 in your savings account, what will be your marginal propensity to consume?

Margin propensity to consume = a change in consumption/a change in income

$200/$300 = .66 cents for each additional dollar of income

If, however, you decide not to spend any of your bonus and instead put all $300 into your savings account, your marginal propensity to consume would be 0.

Effects on Individuals

So how does the marginal propensity to consume affect an individual? Well, this depends on a few factors. First, there is income. When someone has a low income and suddenly gets more money, they will be more likely to consume goods than someone with a high income. This is because those with a higher income are more readily able to satisfy their needs and wants on a regular basis and thus do not feel as strong of an urge to spend the increase in income. But, those with a low income may not be able to afford luxuries, and, therefore, when they do get extra income, they may be more tempted to finally purchase goods that they usually would not be able to buy.

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