Marginal Propensity to Consume

Definition

The marginal propensity to consume (MPC) is the fraction of an additional unit of income that a consumer will spend on consumption. It represents the relationship between changes in income and changes in consumption, measuring how much of an increase in income will be spent on consumption rather than saved.

5 Must Know Facts For Your Next Test

1. The marginal propensity to consume is a key concept in Keynesian economics, which emphasizes the role of aggregate demand in determining the level of output and employment.
2. A higher marginal propensity to consume means that a larger fraction of additional income will be spent on consumption, leading to a greater multiplier effect on economic activity.
3. The marginal propensity to consume is influenced by factors such as income distribution, wealth, consumer expectations, and interest rates.
4. In the context of income inequality, a higher marginal propensity to consume among lower-income individuals can lead to a greater stimulative effect on the economy when income is redistributed.
5. The marginal propensity to consume is a crucial parameter in the Keynesian analysis of aggregate demand and the determination of equilibrium output.

Review Questions

• Explain how the marginal propensity to consume relates to the Keynesian perspective on demand and supply.
  • The marginal propensity to consume is a central concept in Keynesian analysis of aggregate demand. According to Keynesian theory, changes in income lead to changes in consumption spending, with the marginal propensity to consume determining the magnitude of this relationship. A higher MPC means that a larger fraction of additional income will be spent on consumption, leading to a greater multiplier effect on aggregate demand and output. This Keynesian perspective emphasizes the role of demand-side factors, such as consumption, in determining the equilibrium level of output, in contrast to the classical view that focuses on supply-side factors.
• Describe how the marginal propensity to consume relates to shifts in aggregate demand.
  • The marginal propensity to consume is a key determinant of the size of the multiplier effect, which influences the magnitude of shifts in aggregate demand. A higher MPC means that a larger fraction of additional income will be spent on consumption, leading to a greater increase in aggregate demand for a given change in income. This, in turn, results in a larger shift in the aggregate demand curve in response to changes in factors like government spending, taxes, or consumer expectations. Conversely, a lower MPC implies a smaller multiplier effect and a more muted shift in aggregate demand following changes in these determinants.
• Evaluate the role of the marginal propensity to consume in the Keynesian perspective on market forces and government spending.
  • The Keynesian perspective emphasizes the importance of the marginal propensity to consume in understanding the role of market forces and the potential for government intervention. A high MPC suggests that changes in income can have a significant impact on consumption and, consequently, on aggregate demand and output. This provides a rationale for government policies aimed at stimulating consumption, such as tax cuts or transfer payments, as these can lead to a larger multiplier effect and a more pronounced increase in economic activity. Conversely, a low MPC may limit the effectiveness of such demand-side policies, suggesting a greater role for supply-side measures or direct government spending to influence the level of output. The Keynesian view thus highlights the marginal propensity to consume as a crucial factor in evaluating the appropriate policy response to macroeconomic conditions.

Related terms

Marginal Propensity to Save: The marginal propensity to save (MPS) is the fraction of an additional unit of income that a consumer will save rather than spend on consumption.

Consumption Function:

The consumption function is an economic model that describes the relationship between a consumer's income and their consumption spending.

Keynesian Cross: The Keynesian cross is a graphical model that illustrates the relationship between aggregate expenditure and real GDP, with the equilibrium level of output determined by the intersection of the 45-degree line and the aggregate expenditure function.