The Consumption Puzzle: Why People Don’t Spend All Their Income and What It Means for Economies

One of the most fascinating insights from Keynesian economics is the recognition that people do not spend all of their additional income. Instead, they save a portion, a behavior captured by the concept of the marginal propensity to consume (MPC). This seemingly simple idea has profound implications for economic growth and stability.

Imagine a family receiving a bonus or a raise. They might spend some of it on immediate needs or luxuries, but a part is saved for future security. When multiplied across millions, this behavior means that increases in income do not translate into proportional increases in demand, which is crucial for job creation and economic expansion.

During times of uncertainty, businesses may hesitate to invest, and consumers may hoard cash, leading to a liquidity trap where even near-zero interest rates fail to encourage spending or investment. This phenomenon limits the effectiveness of monetary policy and calls for active fiscal measures.

Understanding these behavioral nuances helps explain why economies sometimes stall and why policymakers must carefully design interventions that consider human psychology as well as economic mechanics. It highlights the delicate balance between consumption, savings, and investment that sustains healthy economic cycles.