how to measure mpc?

The following exercise is designed to allow students to apply their knowledge of the marginal propensity to consume (MPC) and the marginal propensity to save (MPS).

You are an economist that works for a research agency In London. You receive a call from your manager.

"I think it would be very pertinent for you to study the impacts of changing income levels of spending patterns in Uganda. This is because, in the past year, wages in Uganda have increased significantly due to the presence of gold mines. I will send you some data for your analysis."

The data is presented below.

1. Calculate the annual change in the average income level and the average consumption level in Uganda.

2. Compute the MPC based on your findings.

3. Is it possible to determine the MPS based on this information alone? If so, please compute it.

1.

We will use the following formula:

Annual change = (Current data - Previous data) / Previous data

See below.

2.

MPC = Change in consumption / Change in income

= 1,500/ 4,000

= 0.375

The answer is 0.375.

3.

Yes, it is possible because the MPS is always equal to:

MPS = 1 - MPC

In other words, Marginal Propensity to Consume (MPC) measures the proportionate rise in the consumption with increase in income or we can say it measures the proportion of extra pay that is spent on consumption of goods and services rather than saving it.

Marginal Propensity to Consume or MPC is dependent on the income level. It may vary with the income levels and it can be seen that the MPC is lower at higher income levels.

MPC can be calculated by determining the change in consumption divided by the change in income.

MPC is represented by the consumption line, which is a sloped line that is formed when change in consumption is plotted on the vertical y-axis with change in income on the horizontal x-axis.

MPC has always been concerned with the relationship between the consumption and changes in income. It is considered that higher income levels lead to lower consumption which leads to low MPC.

MPC also is a key determinant of the multiplier effect which is the impact of increased investment or government spending that results in increase in GDP.

MPC plays a key role by controlling the size of the multiplier as a higher MPC will result in a greater multiplier effect, while a lower MPC means low impact on the multiplier.

This can be illustrated from the following formula.

k = 1/ 1- MPC

Where k = Multiplier effect

MPC = Marginal Propensity to Consume

MPC can be calculated with the following formula

MPC = Change in Consumption (ΔC) / Change in Income (ΔY)

The value of MPC varies between 0 and 1 normally, but sometimes it can exceed 1, if the need for consumption is more than the change in income.

MPC can be classified into three types, which are

1. MPC more/greater than 1

2. MPC equal to 1

3. MPC less than 1

MPC greater than 1: When MPC value is greater than 1, it signifies that changes in the income levels have triggered a higher level of consumption which surpasses the value of 1. For e.g, if Ram earns a bonus of 1000 and they spent 2000 on purchasing goods.

Then the MPC will be 2. This spending can be attributed to autonomous consumption, which suggests that spending is not based on level of income.

It says that an individual having zero income will still feel the need to have enough food to eat and for that they could borrow or break down their existing savings.

MPC equal to 1: When the MPC is equal to 1, it shows a proportionate increase in income levels leading to an equal increase in the consumption of goods.

MPC less than 1: When MPC will be less than 1, there will be a proportionately smaller increase in the consumption with respect to the change in income levels.

Following factors are responsible for determining the MPC:

Income Levels: The levels of income have an impact on the MPC as a person having a low income level on receiving a boost in income will be looking forward to acquiring many such items that leads to more consumption.

In contrast to that, a person with a higher income level on receiving an income boost will be more interested in savings as he has most of the items necessary for consumption available with him.

Type of Increase in Income: The type of increase in income also has an impact on the MPC as increase in income can be either temporary or permanent. An individual with a temporary rise in income (obtained through bonus or incentives) will be interested in saving that amount, whereas a person receiving the same amount of increase in income, on a permanent basis will be more inclined towards consumption.

Interest Rates: Higher interest rates can encourage individuals towards savings rather than consumption, at the same time, higher interest rates can increase in income from the savings, which leads to more consumption.

Consumer Confidence: If the consumer confidence in the economy is high, it can result in people increasing their consumption. If the mentality of the population is pessimistic which can be due to rising unemployment or recession, it will result in delay in purchasing decisions, which can result in a lower MPC.

This concludes our article on the topic of Marginal Propensity to Consume, which is an important topic in Economics for Commerce students. For more such interesting articles, stay tuned to BYJU’S.

Marginal propensity to consume (MPC) is defined as the share of additional income that a consumer spends on consumption. That means it describes the percentage of additional income they spend on buying goods and services, instead of saving. Hence, the marginal propensity to consume can be calculated as the change in consumption (ΔC) divided by the change in income (ΔY). This can be expressed using the following formula:

MPC = ΔC / ΔY

Starting from there, we will analyze that formula in the following paragraphs and learn how to calculate the marginal propensity to consume step-by-step.

First, we have to find the change in income (ΔY). Note that the Δ sign is the Greek letter delta, which is commonly used as a mathematical symbol for a difference between two values. That means the change in income describes the change in the level of income between a certain point in the past (Y0) and a more recent point in time (Y1). Thus, to find the change in income, all we have to do is subtract Y0 from Y1.

For example, let’s say you have a friend called Emily, who works at a restaurant as a waitress. At that restaurant, she earns a salary of USD 25,000 per year. However, because Emily is such a talented and hard-working employee, she’s soon promoted to be the assistant restaurant manager. Along the new position comes a raise. Thus, now her salary is USD 30’000 per year. As a result, the change in Emily’s income amounts to USD 5,000 (i.e., 30,000 – 25,000).

Next, we have to calculate the change in consumption (ΔC) to find MPC. Again, that means we are looking for the difference in the level of consumption between two specific points in time (i.e., C0 and C1). More specifically, we are calculating the change in consumption before and after the change in income (see above). The reason for this is that we want to find out how much of the additional income is used for consumption.

To illustrate this, let’s revisit your friend Emily. Before her promotion, Emily spent about USD 20,000 out of her USD 25,000 salary on consumption. This includes all kinds of expenditures, such as rent, food, clothing, and so on. In addition to that, she put the remaining USD 5,000 in her savings account. After the promotion, Emily has more money available, so she decides to use some of it to go on vacation. As a result, her consumption spending increases from USD 20,000 to USD 23,000. Thus, the change in Emily’s consumption adds up to USD 3,000 (i.e., 23,000 – 20,000).

Once we have calculated both the change in income and the change in consumption, we can calculate the marginal propensity to consume by dividing the change in consumption by the change in income. Note that the value of MPC will always range from 0 to 1. If all additional income is used for consumption, ΔY is equal to ΔC, which results in an MPC of 1. Meanwhile, if none of the additional income is used for consumption, ΔC is 0, which results in an MPC of 0.

For example, in the case of your friend Emily, the change in income is USD 5,000. Out of this additional income, she spends USD 3,000 on her vacation. Therefore, her marginal propensity to consume is 0.6 (i.e., 3,000/5,000). That means she spends 60% of her additional income on consumption. However, if Emily decided to extend her vacation and spend all the additional income on it, her MPC would be 5,000/5,000, which is equal to 1, or 100%. Similarly, if she decided to save all her additional money, instead, her MPC could be calculated as 0/5000, which is equal to 0.

Marginal propensity to consume (MPC) is defined as the share of additional income that a consumer spends on consumption. It can be calculated as the change in consumption (ΔC) divided by the change in income (ΔY). Thus, the value of MPC will always range from 0 to 1. If all additional income is used for consumption, MPC is 1, because ΔY is equal to ΔC. Meanwhile, if none of the additional income is used for consumption, MPC is 0, because ΔC is 0.

A person or household's additional income can be either spent or saved. The marginal propensities to consume and to save are respectively calculated by dividing the change in spending and in saving by the total change in income. The MPC formula can be expressed symbolically as:

$$MPC = \dfrac{ \Delta C}{\Delta I} $$

and the MPS formula is expressed similarly:

$$MPS = \dfrac{ \Delta S}{\Delta I} $$

The Greek letter {eq}\Delta {/eq} ("delta") is often used to signify a change in a certain quantity. The variables used in the formulas are:

The calculated decimal values of the MPS and MPC can be interpreted as the portion of each new dollar of income that will be saved or consumed, or converted to a percentage by multiplying by 100%. For example, an MPS value of 0.20 would represent 20 cents (0.20/$1.00) is saved out of every dollar, which is a savings rate of 20%.

Here are some example scenarios showing how to calculate MPS and how to calculate MPC.

Last year, Shireen earned $40,000 and was able to save $5,000. This year, she received a raise, increasing her salary to $45,000, which allowed her to save $6,000. What is her marginal propensity to save?

The MPS formula provided above can be applied, after identifying the year-over-year change in Shireen's income and savings. Her change in income was:

$$\Delta I = \$45,\!000 - \$40,\!000 = \$5,\!000 $$

The corresponding change in her savings was:

$$\Delta S = \$6,\!000 - \$5,\!000 = \$1,\!000 $$

Shireen's MPS was

$$MPS = \dfrac{ \Delta S}{\Delta I} = \dfrac{ \$1,\!000 } {\$5,\!000 } = 0.20 = 20\% $$

Shireen was able to save 20% of the additional income she earned, or 20 cents out of every additional dollar. The MPS can be interpreted visually as the slope between initial and final points on a graph of savings versus income.

Steve earns a regular bi-weekly pay check of $2,586.50. At the end of his most recent pay period, he received a $400 performance bonus, of which he spent $249.53 in a shopping spree. What is his marginal propensity to consume?

The change in Steve's income is only the amount of the bonus, since the regular, total amount represents his current level of income and not a change in circumstance. Stated symbolically:

$$\Delta I = \$400 $$

The corresponding change in consumption was

To calculate the marginal propensity to consume, the change in consumption is divided by the change in income. For instance, if a person's spending increases 90% more for each new dollar of earnings, it would be expressed as 0.9/1 = 0.9.