In the following passage, what important concept is Keynes introducing here? Why is this concept important to modern macroeconomics? Explain with an example

Keynes is introducing psychological law of consumption.

According to psychological law of consumption, increase in income would lead to increase in consumption, but the amount of increase in consumption would be less than the amount of increase in income. The amount of increase in consumption with respect to increase in income is called as marginal propensity to consume.

This behaviour of household is of a great deal for Macroeconomic analysis and policy formation because the consumption decisions made by the households affect the economy. Consumption expenditure is a largest part of gross domestic product and largest part of aggregate demand. Aggregate demand directly impacts price level and Real GDP in the economy.

Increase in consumption expenditure, leads to increase in aggregate demand, which leads to higher production of goods and services, which increases demand for labor and thus increases employment in the economy. Higher employment generates income, which further fuels demand and thus cycle of economic growth continues.

Thus psychological law of consumption is very important from macroeconomic point of view, as it has direct implications on employment, inflation, income, Real GDP, etc.