The marginal propensity to consume is critical to the macroeconomy and the study of Keynesian economics. First, the MPC captures induced consumption and the fundamental psychological law of consumer spending proposed by John Maynard Keynes as a key difference between his Keynesian theory and classical economics. Second, the MPC is the slope of the consumption line, which makes it the foundation for the slope of the aggregate expenditures line, as well. Third, the MPC affects the multiplier process and affects the magnitude of the expenditures and tax multipliers.

The MPC Formula

MPC

=

change in consumption change in income

• First, it quantifies induced consumption, that is, how much of each extra dollar of income is used for consumption. If income changes by $1, then consumption changes by the value of the MPC. Income induces the change in consumption at a rate measured by the MPC.


• Second, the MPC is actually a measure of the slope of the consumption line. The measurement of slope is generally given as the "rise" over the "run." For the consumption line, the rise is the change in consumption and the run is the change in income.

A Schedule Of Numbers

Consumption Schedule

The marginal propensity to consume is calculated by dividing the change in consumption in the second column by the change in income in the first column. Beginning at the top of the schedule, household income increases from $0 to $1 trillion. This $1 trillion change in income induces a change in consumption from $1 trillion to $1.75 trillion, a change of $0.75 trillion.

Running the numbers through the MPC formula gives:

MPC

=

change in consumption change in income

=

$0.75 $1

=

0.75

In fact, a quick run through the numbers for each change in consumption shows that the MPC is constant and equal to 0.75. To display all marginal propensity to consume values, click the [MPC] button.

While the MPC is not necessarily constant at for all changes in income (in fact, the MPC tends to decline at higher income levels), most analysis of consumption generally works with a constant MPC. It tends to make subsequent calculations for things like the multiplier a lot easier.

The Slope Of The Line

Consumption Line

This consumption line reflects a plot of the numbers in the consumption schedule as well as the following consumption function:

C

=

1

+

0.75Y

In particular, as specified by the consumption function, the slope of this consumption line is equal to 0.75. This slope value indicates that each $1 change in income induces a $0.75 change in consumption. In general, slope is calculated as the "rise" over the "run," that is, the change in the variable on the vertical axis (consumption) divided by the change in the variable on the horizontal axis (income).

The change in consumption divided by the change in income is the specification of the marginal propensity to consume. That is, the slope of the consumption line is the marginal propensity to consume. To highlight this point, click the [Slope] button in this exhibit.

Moreover, because the consumption line is a straight line, the slope is constant over the entire range of income. This means that the marginal propensity to consume is also constant, a conclusion reached when working through the consumption schedule.

Multiplier

The magnified change occurs because a change in production (such as what occurs when investment expenditures purchase capital goods) generates income, which then induces consumption. However, the resulting consumption is also an expenditure on production, which generates more income, which induces more consumption. This next round of consumption also triggers a change in production, which generates even more income, and which induces even more consumption.

And on it goes, round after round. The end result is a magnified, multiplied change in aggregate production initially triggered by the change investment, but amplified by the change in consumption.

The MPC enters into the process because it determines how much consumption is induced with each change in production and income. If the MPC is greater, then the multiplier process is also greater as more consumption is induced with each round of activity.

This connection between the multiplier process and the marginal propensity to consume is illustrated in the standard formula for a basic expenditures multiplier:

expenditures multiplier

=

1 (1 - marginal propensity to consume)

For example, a marginal propensity to consume of 0.75 results in a multiplier of 4. In contrast, a larger marginal propensity to consume of 0.8 results in a larger multiplier of 5.

Other Marginals

Here a few of the more important marginals:

• Marginal Propensity to Save: The flip side of consumption is saving. The fundamental psychological law indicates that an increase in income induces changes in both consumption and saving. The marginal propensity to save (MPS) quantifies the saving part of this relation. It indicates the change in saving resulting from a change in income. In fact, if the MPC and MPS are calculated based on after-tax disposable income, then the two marginals sum to one: MPC + MPS = 1.


• Marginal Propensity to Invest: Consumption is not the only one of the aggregate expenditures induced by income and with a corresponding marginal. The marginal propensity to invest (MPI) is the change in investment induced by a change in income. The induced change in investment is not nearly as big as consumption, but it does affect the slope of the aggregate expenditures line and the size of the multiplier.


• Marginal Propensity for Government Purchases: Government purchases, like investment, is also induced by income and has a corresponding marginal. The marginal propensity for government purchases (MPG) is the change in government purchases induced by a change in income. The induced change in government purchases is related to the induced change in tax collections, and while it also small compared to consumption, but it too affects the slope of the aggregate expenditures line and the size of the multiplier.


• Marginal Propensity to Import: The last of the four aggregate expenditures, net exports (exports minus imports), also has a corresponding marginal. However, the marginal is not for net exports proper, but for the imports part. The marginal propensity to import (MPM) is the change in imports induced by a change in income. The induced change in imports is closely connected to the marginal propensity to consume. That is, a portion of consumption expenditures is actually used to purchase imports, which is reflected the marginal propensity to import.

Average Propensity to Consume

The formula for calculating average propensity to consume (APC) looks a lot like that for the MPC, but with important differences:

APC

=

consumption income