Marginal_propensity_to_consume

The marginal propensity to consume (MPC) refers to the increase in personal consumer spending (consumption) that occurs with an increase in disposable 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 family will spend 65 cents and save 35 cents.

Mathematically, the marginal propensity to consume (MPC) function is expressed as the derivative of the consumption (C) function with respect to disposable income (Y).

$MPC=\backslash frac\{dC\}\{dY\}$

In other words, 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 save (in a two sector closed economy), both of which are crucial to Keynesian economics and are key variables in determining the value of the multiplier.

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 multiplier 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). 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
• Average propensity to save
• Average propensity to consume
• Consumer theory
• Keynesian economics

References

Robert Barro and Vittorio Grillio (1994), European Macroeconomics, Macmillan Publishers. ISBN 0-333-577764-7.

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