Assume that you got a raise of $1 per day. What options do you have in using this additional income? How much of this $1 will you spend and how much will you save? How does this relate to the marginal propensity to consume?

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When we get more income, we have two main options for what to do with the money.  First, we can spend it.  Of course, we can spend it on a variety of things.  We can spend it on something that is meant to help us in the future, like a college education.  We can spend it on things that we want in the present.  But the basic idea is that one of our options is to spend that money.  Second, we can save the money.  We can put it in the bank or we can buy something like stocks or bonds.

Each person who gets the extra $1 per day will make their own decision about what to do with that money.  That decision will depend on a variety of things.  One of the major factors will be how the person’s current income matches up with their needs.  If a person’s current income is above what they need, they might not spend any of the extra $1.  Another person who has more needs relative to income might spend the entire $1.  I suspect that I would spend very little of the extra $1.  I might spend something like $.10.

The amount that I choose to spend is my marginal propensity to consume (MPC).  Since I will only spend 10% of my extra dollar, my MPC is .1.

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