What is Marginal Propensity To Consume (MPC)?
The marginal propensity to consume (MPC) is the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. Marginal propensity to consume is a component of Keynesian macroeconomic theory and is calculated as the change in consumption divided by the change in income. MPC is depicted by a consumption line, which is a sloped line created by plotting change in consumption on the vertical "y" axis and change in income on the horizontal "x" axis.
- Marginal Propensity to Consume is the proportion of an increase in income that gets spent on consumption.
- MPC varies by income level. MPC is typically lower at higher incomes.
- MPC is the key determinant of the Keynesian multiplier, which describes the effect of increased investment or government spending as an economic stimulus.
Marginal Propensity to Consume
Understanding Marginal Propensity To Consume (MPC)
The marginal propensity to consume is equal to ΔC / ΔY, where ΔC is change in consumption, and ΔY is change in income. If consumption increases by 80 cents for each additional dollar of income, then MPC is equal to 0.8 / 1 = 0.8.
Suppose you receive a $500 bonus on top of your normal annual earnings. You suddenly have $500 more 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 $100, your marginal propensity to consume will be 0.8 ($400 divided by $500).
The other side of marginal propensity to consume is marginal propensity to save, which shows how much a change in income affects levels of saving. Marginal propensity to consume + marginal propensity to save = 1. In the suit example, your marginal propensity to save will be 0.2 ($100 divided by $500).
If you decide to save the entire $500, your marginal propensity to consume will be 0 ($0 divided by 500), and your marginal propensity to save will be 1 ($500 divided by 500).
MPC and Economic Policy
Given data on household income and household spending, economists can calculate households’ MPC by income level. This calculation is important because MPC is not constant; it varies by income level. Typically, the higher the income, the lower the MPC, because as income increases, more of a persons wants and needs become satisfied so they save more instead. At low income levels MPC tends to be much higher as most or all of the person's income must be devoted to subsistence consumption.
According to Keynesian theory, an increase in investment or government spending increases consumers’ income, and they will then spend more. If we know what their marginal propensity to consume is, then we can calculate how much an increase in production will affect spending. This additional spending will generate additional production, creating a continuous cycle via a process known as the Keynesian multiplier. The larger the proportion of the additional income that gets devoted to spending rather than saving, the greater the greater the effect. The higher the MPC, the higher the multiplier—the more the increase in consumption from the increase in investment—so if economist can estimate the MPC then they can use it to estimate the total impact of a prospective increase in incomes.