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 AmosWEB means Economics with a Touch of Whimsy! RESERVES: The vault cash and deposits at the Federal Reserve System that banks use to complete day-to-day transactions.                              MARGINAL PROPENSITY TO CONSUME:

The proportion of each additional dollar of household income that is used for consumption expenditures. The marginal propensity to consume (abbreviated MPC) is another term for the slope of the consumption line and is calculated as the change in consumption divided by the change in income. The MPC plays a central role in Keynesian economics. It quantifies the consumption-income relation and the fundamental psychological law. It is also a foundation for the slope of the aggregate expenditures line and is critical to the multiplier process. A related consumption measure is the average propensity to consume.
The marginal propensity to consume (MPC) indicates what the household sector does with extra income. The MPC indicates the portion of additional income that is used for consumption expenditures. If, for example, the MPC is 0.75, then 75 percent of extra income goes for consumption.

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

The standard formula for calculating marginal propensity to consume (MPC) is:
 MPC = change in consumptionchange in income
This formula has a couple of interpretations.
• 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 A consumption schedule, such as the one presented to the right, provides data that can be used to run through a few MPC calculations. The first column in this schedule presents household income, ranging from \$0 to \$10 trillion. The second column presents consumption expenditures, ranging from \$1 to \$8.5 trillion. The task at hand is to derive the marginal propensity to consume at each income level.

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 consumptionchange in income = \$0.75\$1 = 0.75
Calculations for each change in income produce similar results. For example, the change in income from \$4 trillion to \$5 trillion results in a change in consumption from \$4 trillion to \$4.75 trillion. And the change in income from \$8 trillion to \$9 trillion results in a change in consumption from \$7 trillion to \$7.75 trillion. In both cases, the resulting marginal propensity to consume is 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 The marginal propensity to consume is another term for the slope of the consumption line. This can be demonstrated and illustrated using the red consumption line, labeled C, in the exhibit to the right. Most notable, the consumption line is positively sloped, indicating that greater levels of income generate greater consumption expenditures by the household sector.

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

 C = 1 + 0.75Y
Just for a little reference, a black 45-degree line is also presented in this exhibit. Because this 45-degree line, by its very nature, has a slope of one, it indicates the relative slope of the consumption line. The flatter consumption has a slope of less than one.

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

While the marginal propensity to consume pops up throughout the study of macroeconomics, few if any topics are more important than the multiplier. The multiplier measures the magnified change in aggregate production (gross domestic product) resulting from a change in an autonomous variable (such as investment expenditures).

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:

 expendituresmultiplier = 1(1 - marginal propensity to consume)
An increase in the marginal propensity to consume reduces the value of the denominator on the right-hand side of the equation, which then increases the overall value of the fraction and thus the size of the multiplier.

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

The marginal propensity to consume is perhaps the most important marginal that enters into the study of Keynesian economics. However, it is not the only important marginal. In fact, all induced variables have corresponding marginals that quantify the impact of income changes.

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 marginal propensity to consume is one of two measures of the relation between consumption and income. The other is average propensity to consume (APC). Average propensity to consume is the proportion of household income used for consumption expenditures. It is found by dividing consumption by income.

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

 APC = consumptionincome
Rather than the CHANGE in consumption divided by the CHANGE in income, the APC measures TOTAL consumption divided by TOTAL income. In particular, the APC indicates how the household sector divides up total income. If, for example, the APC is 0.9, then 90 of the income received by the household sector is used for consumption. Moreover, whereas the MPC is constant, the APC actually changes from one income level to the next.

 <= MARGINAL PROPENSITY FOR GOVERNMENT PURCHASES MARGINAL PROPENSITY TO IMPORT => Recommended Citation:

MARGINAL PROPENSITY TO CONSUME, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2020. [Accessed: November 28, 2020].

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