In
economicsEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the
marginal propensity to consume (MPC) is an empirical metric that quantifies
induced consumptionInduced consumption is a term used to describe consumption expenditure by households on goods and services which varies with income. Such consumption is considered induced by income when expenditure on these consumables varies as income changes....
, the concept that the increase in personal consumer spending (
consumptionConsumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally consumption is defined by opposition to production. But the precise definition can vary because different schools of economists define production quite differently...
) that occurs with an increase in
disposable incomeDisposable income is gross income minus income tax on that income. In national accounts definitions, personal income, minus personal current taxes equals disposable personal income...
(income after taxes and transfers). For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents.
Mathematically, the marginal propensity to consume (MPC) function is expressed as the
derivativeIn calculus the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much a quantity is changing at a given point; for example, the derivative of the position of a vehicle with respect to time is the instantaneous velocity...
of the consumption (C) function with respect to disposable income (Y).
OR
, where a is the change in consumption, and b is the change in disposable income that produced the consumption.
For example, suppose you receive a bonus with your paycheck, and it's $500 on top of your normal annual earnings.
In
economicsEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the
marginal propensity to consume (MPC) is an empirical metric that quantifies
induced consumptionInduced consumption is a term used to describe consumption expenditure by households on goods and services which varies with income. Such consumption is considered induced by income when expenditure on these consumables varies as income changes....
, the concept that the increase in personal consumer spending (
consumptionConsumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally consumption is defined by opposition to production. But the precise definition can vary because different schools of economists define production quite differently...
) that occurs with an increase in
disposable incomeDisposable income is gross income minus income tax on that income. In national accounts definitions, personal income, minus personal current taxes equals disposable personal income...
(income after taxes and transfers). For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents.
Mathematically, the marginal propensity to consume (MPC) function is expressed as the
derivativeIn calculus the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much a quantity is changing at a given point; for example, the derivative of the position of a vehicle with respect to time is the instantaneous velocity...
of the consumption (C) function with respect to disposable income (Y).
OR
, where a is the change in consumption, and b is the change in disposable income that produced the consumption.
For example, suppose you receive a bonus with your paycheck, and it's $500 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 business suit, your marginal propensity to consume will be 0.8 .
The marginal propensity to consume is measured as the ratio of the change in consumption to the change in income, thus giving us a figure between 0 and 1. The MPC can be more than one if the subject borrowed money to finance expenditures higher than their income. One minus the MPC equals the
marginal propensity to saveThe marginal propensity to save refers to the increase in saving that results from an increase in income. For example, if a household earns one extra dollar, and the marginal propensity to save is 0.35, then of that dollar, the household will spend 65 cents and save 35 cents...
(in a two sector closed economy), both of which are crucial to
Keynesian economicsKeynesian economics is a macroeconomic theory based on the ideas of 20th-century British economist John Maynard Keynes...
and are key variables in determining the value of the
multiplierIn economics, the multiplier effect or spending multiplier is the idea that an initial amount of spending leads to increased consumption spending and so results in an increase in national income greater than the initial amount of spending...
.
The MPC relies heavily upon the real (inflation-adjusted) rate of interest. A high rate of interest causes spending in the future to become increasingly attractive due to the intertemporal substitution effect on consumption. Because a rate increase primarily decreases the present value of lifetime wealth, the consumer relies on becoming a lender to offset this effect. In a two period model, as S(1+r) increases with the interest rate, so does future income[C= -(1+r)c +we(1+r)]. Therefore, every dollar of current income spent by the consumer is 1(1+r) dollars the consumer will not be able to spend in the second period.
Economists often distinguish between the marginal propensity to consume out of permanent income, and the marginal propensity to consume out of temporary income, because if a consumer expects a change in income to be permanent, then they have a greater incentive to increase their consumption (Barro and Grilli, p. 417-8). This implies that the Keynesian
multiplierIn economics, the multiplier effect or spending multiplier is the idea that an initial amount of spending leads to increased consumption spending and so results in an increase in national income greater than the initial amount of spending...
should be
smaller in response to permanent changes in income than it is in response to temporary changes in income (though the earliest Keynesian analyses ignored these subtleties). However, the distinction between permanent and temporary changes in income is often subtle in practice, and it is often quite difficult to designate a particular change in income as being permanent or temporary. What is more, the marginal propensity to consume should also be affected by factors such as the prevailing interest rate and the general level of consumer surplus that can be derived from purchasing.
See also
- Marginal propensity to save
The marginal propensity to save refers to the increase in saving that results from an increase in income. For example, if a household earns one extra dollar, and the marginal propensity to save is 0.35, then of that dollar, the household will spend 65 cents and save 35 cents...
- Average propensity to save
The average propensity to save , also known as the savings ratio, is an economics term that refers to the proportion of income which is saved, usually expressed for household savings as a percentage of total household disposable income. The ratio differs considerably over time and between countries...
- Average propensity to consume
Average propensity to consume is the percentage of income spent. To find the percentage of income spent, one needs to divide consumption by income, or...
- Consumer theory
Consumer theory is a theory of microeconomics that relates preferences to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most complex relations in economics...
- Keynesian economics
Keynesian economics is a macroeconomic theory based on the ideas of 20th-century British economist John Maynard Keynes...