In economics, the Marginal Propensity to Consume (MPC) is the proportion of an aggregate raise in income that consumers spend on goods and services rather than saving it. Key to Keynesian macroeconomic theory, MPC is calculated as the change in consumption divided by the change in income.
Key Takeaways
- Marginal propensity to consume measures the ratio of an increase in consumer spending prompted by an increase in income.
- MPC typically varies by income level; it tends to decrease as income rises because at higher income levels, consumption needs are more likely to be met and more income may be saved.
- MPC is a central element in calculating the Keynesian multiplier, which describes how increased investment or government expenditure stimulates the economy.
A Closer Look at Marginal Propensity To Consume (MPC)
MPC is expressed in the equation form as ΔC / ΔY, where ΔC stands for the change in consumption and ΔY represents the change in income. For example, if a consumer’s spending increases by $0.80 for every additional dollar of income received, the MPC would be 0.8 ($0.80 / $1.00).
For instance, if you receive a $500 bonus and decide to use $400 for purchasing a new suit and save the remaining $100, your MPC is then 0.8 ($400 divided by $500).
Conversely, the marginal propensity to save measures the proportion of income change allocated to savings. Thus, the two ratios always sum up to 1:
Marginal Propensity to Consume + Marginal Propensity to Save = 1
In the prior example, the marginal propensity to save (MPS) would thus be 0.2 ($100 divided by $500). Should you decide to save the entire additional sum, the MPC would be zero (0 divided by 500), and the MPS would equal one (500 divided by 500).
The Impact of MPC on Economic Policies
By analyzing data on household income and spending, economists can determine the MPC by income stratification. Typically, higher income levels correspond with a directly lower MPC, as increased income satisfaction levels allow for more saving rather than consuming. Conversely, lower incomes often translate to a higher MPC since much or all of that income needs to be devoted to living expenses.
Keynesian theory posits that increased government investments or expenditures result in heightened consumer incomes, subsequently prompting higher consumer spending. Precise knowledge of MPC allows economists to gauge how increases in production will impact spending levels.
Additionally, this uptick in consumer expenditure stimulates further production—coined as the Keynesian multiplier effect. As a key indicator, the higher the MPC, the greater the multiplier; this leads to a higher total consumption resulting from increased direct investments.
Simplifying the Marginal Propensity To Consume
Put simply, the marginal propensity to consume gauges how much of a pay raise a consumer will allocate to spending versus saving. Typically, higher income levels equate to lower MPC because economic needs become satiated thus allowing for more savings. In contrast, those with lower incomes might display a heightened marginal propensity to consume, directing a higher proportion of their incomes toward daily expenses.
Calculating Marginal Propensity To Consume
To determine MPC, simply divide the change in consumption by the change in income. For example, if an individual’s spending rises by 90 cents for each new dollar of earnings, this would translate to an MPC of 0.9 (0.9/1).
Alternatively, if someone receives a $1,000 bonus and spends $100 while saving the remaining $900, then the MPC would be $100 / $1,000, equating to 0.1.
MPC’s Influence in Economics
Within the framework of Keynesian macroeconomics, MPC is vital in understanding the multiplier effect from economic stimulus activities. Effective government spending should theoretically lead to increased consumer incomes and, sequentially, heightened aggregate consumer spending, boosting overall demand. Understanding MPC enables economists to project the extent of growth triggered by policy changes or investment increases.
Related Terms: Marginal Propensity to Save, Keynesian Multiplier, Income Effect, Multiplier Effect.
References
- David Shapiro et al. “Principles of Macroeconomics 3e”. Pages 551-554. OpenStax, 2022. Download PDF.
- Corporate Finance Institute. “Keynesian Multiplier”.
- Corporate Finance Institute. “Marginal Propensity To Consume”.
- International Monetary Fund. “What Is Keynesian Economics?”
- Corporate Finance Institute. “Keynesian Multiplier”.
