You know your raise is due tomorrow. It’s been a year of hard work and you know that the appraisal is long due and well deserved. So now that you know that a little more than usual is going to enter your bank account this month on, I’m sure you’ll have some plans for it? Maybe a party for your friends, something for the house, a cool new gadget perhaps? Great going!! But, before that, read the article below, which will tell you how to calculate the marginal propensity to consume.
To spend or not to spend? That is the question. And how much you do spend is what the marginal propensity to consume talks about. As the definition goes – it is the increase in consumer spending with an increase in disposable income. Whether one chooses to spend his basic income or perhaps more accurately, how much he chooses to spend is his propensity to consume is important. And since it has something to do with a slight increase over normal (in this case, the disposable income) the world ‘marginal’ comes into play in this concept.
While slightly technical and complicated sources with a lot of Greek alphabets will completely confuse you with this otherwise terribly simple formula, a much simpler, easy-to-use version of it is given here.
Marginal Propensity to Consume = Change in Consumption (C)/Change in Disposable Income (Y)
So basically, if you get a US$ 100 raise, and you spend US$ 80 of it for whatever purpose, then your marginal propensity to consume is –
80/100 = 0.8
What this formula does is that it equates two variables, which are central to this concept – the disposable income and the consumption. It pretty much espouses a basic assumption that with an increase in disposable income, there will be an increase in consumption, because well, lets face it, not too many people feel encouraged to reduce spending while at the receiving end of an increase in income!
Of course, this economic concept is not a stand-alone one and comes with a variety of ifs and buts with it.
- Recession: After facing a big one, which has lasted for nearly two years by now, one cannot simply overlook the range of impacts of an economic recession. During a recession, the marginal propensity to consume of the people is generally lower, as people choose to hang on to and save every penny that they can lay their hands on. Conversely, during a period of boom with rising salaries, it will be a lot higher.
- Monetary Volatility: How stable is your currency? Does the exchange rate fluctuate a lot, when you compare it with other currencies? What is the rate of inflation like? Is the GDP showing stable growth over a sustained period of time? Because, if the currency fluctuates a lot and the inflation is pretty high, then the marginal propensity to consume will be relatively lower, as people tend to spend their earnings more prudently.
- Age of the Sample: It is widely and perhaps correctly assumed, that the younger lot tends to spend a lot more than the older lot. So, if the sample population you are assuming for testing the concept is a younger lot, more often than not, the marginal propensity to consume is relatively higher.
- Job Security: If you work for the government on in the armed forces, chances are quite high that you may never lose your job. And with an employment guarantee, one is entitled to feel a bit lax with his or her spending as compared to say someone who has the sword of unemployment dangling right above his head, ready to fall any time. So, for people in a more secure sort of job, the marginal propensity to consume is higher.
So, this discussion more or less, puts to rest all your questions. It’s less of a theory in itself and more of a basic and widely occurring term in Keynesian economics, in which the macroeconomic situation of a country is studied. It simply lays down the likelihood of spending over saving.