The Wealth Effect and MPC

The marginal propensity to consume (MPC), or the ratio of the change in aggregate consumption compared to the change in aggregate income, is a key component of Keynesian macroeconomic theory. In the United States, it tends to be higher than many other countries around the world. This also means Americans tend to save less than the citizens of other countries.

Marginal Propensity to Consume

Economists and statisticians often approximate the marginal propensity to consume in the United States at around 5 percent.  This is different than the average propensity to consume (APC), which is lower in the United States than many countries. While APC measures the portion of all income used for consumption, MPC measures the change in consumption given a change in income.

For instance, suppose you receive a $1,000 bonus on top of your typical annual earnings. You suddenly have $1,000 positive change in income than you did before. If you decide to spend $400 of this marginal increase in income on a new suit and save the remaining $600, your marginal propensity to consume will be 0.40 ($400 divided by $1,000).

This higher level of consumption relative to new income is a well-studied phenomenon and has played a key role in economic policy, such as in crafting tax cuts and the low-interest rate policies 1990s and mid-2000s. In fact, marginal propensity to consume figures actually undersell the spend-heavy habits of Americans because they ignore credit cards and home equity lines of credit.

Variations in MPC

It is often speculated that the marginal propensity to consume is higher for poorer individuals than wealthy individuals. This is because basic physical comforts, such as food, shelter, clothing and entertainment, make up a larger fraction of a poor person's income. This tendency is not universal among people or countries. Some wealthy nations, such as Japan and Germany, have relatively low marginal propensities to consume. Likewise, many poor African and Asian countries have relatively high marginal propensities to consume.

The United States, however, is a unique case. Since the U.S. dollar is a de facto reserve currency for many central banks, Americans can essentially trade dollars for cheap foreign goods without ever having to produce an equivalent amount of goods in return. This means American savings rates can be artificially low.

U.S. vs. Rest of the World

The OECD keeps track of some country's estimated MPC, so we can compare how the U.S. spends new income, on average, compared to other nations.