What is the Marginal Propensity to Consume

The term ‘Marginal propensity to consume’, shortly abbreviated as MPC is the proportion of each additional dollar of household income that is used for consumption expenditures. The marginal propensity to consume is the slope of the consumption or propensity-to-consume line that forms the foundation for Keynesian economics. The marginal propensity to consume is an economic metric that quantifies the relationship between consumption and income. MPC as an empirical measurement is expressed as a derivative of (C) as the consumption function with respect to (Y) as the disposable income function. In other words, MPC is equal to a fraction of the change in disposal income after consumption.

If you break up the term – Marginal Propensity to Consume-you will find that the Marginal stands for the fact that this number deals with an increase in a base, Propensity stands for a “tendency”, and Consume stands for money that you will go out and spend. So, in effect, it is a fraction that describes how likely you are to spend any extra money that you get, as opposed to saving it. The higher the number-the more likely you are to spend the extra money.

For example If a household’s disposable income after deducting all kinds of taxes rises by 200 dollars, and 165 of that 200 dollars is consumed, the MPC is equal to 83 percent. It is calculated by dividing consumption amount with disposable income. The MPC relies heavily upon the real (inflation-adjusted) rate of interest. Because most of the households divide their income into two parts as savings and expenditure, therefore the sum og propensity to consume and save will always be equal.

Factors that impact Marginal Propensity to Consume

1. Recession – In recessionary times people are more likely to save their extra income than spend it. The US Savings Rate is at a 14 year high similarly, in times of boom, people are more willing to spend than to save. So, the economic cycle has a lot to do with the Marginal Propensity to Consume.

2.Job security – People working in sectors such as defense, government or medicine whose prospect of unemployment is low will have a higher marginal propensity to consume than freelancers and others who don’t have a fixed income and see fluctuating incomes from one month to the other.

3. Volatility:Countries which face more volatility than others will not have citizens willing to save or invest for the long term. The high inflation and volatility breeds uncertainty in people’s minds and they are more happy to spend today rather than save for tomorrow. They figure that the value of their money is going to down anyway because of the inflation or the next wave of depression so might as well have a good time now.

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