Anwar Radharavi

The MPC will invariably be between 0 and 1.

The marginal propensity to consume measures the change in consumption/change in disposable income

The marginal propensity to consume can also be shown by the slope of the consumption function:

Average propensity to consume (APC)

The average propensity to consume = consumption / income

It is possible that consumers could have a marginal propensity to consume of greater than. If income increases £10, in certain circumstances, they may increase spending by £11 – they finance this extra spending by borrowing. More likely is a fall in income of £10, doesn’t cause a fall in spending because people need to maintain certain spending patterns (known as autonomous consumption).

If a worker gains an extra £100, what will be the marginal propensity to consume on UK goods?

There will be three factors (known as withdrawals) which limit the marginal propensity to consume on domestic goods:

These three withdrawals can limit the marginal propensity to consume.

The multiplier effect states that an injection into the circular flow (e.g. government spending or investment) can lead to a bigger final increase in real GDP. This is because the initial injection leads to knock on effects and further rounds of spending.

The marginal propensity to consume will determine the size of the multiplier. The higher the MPC, the greater the multiplier effect will be. If the marginal propensity to consume is 0, there will be no multiplier effect.

The multiplier (k) = 1/1-mpc

For example, if the government pursues expansionary fiscal policy (higher G) but consumer confidence is very low, then there will be a high propensity to save and a low marginal propensity to consume; this will limit the effectiveness of fiscal policy because the injection will lead to only limited increases in spending and aggregate demand.

Marginal propensity to consume and tax cuts

One important issue regarding MPC is the impact of tax cuts. If the government wished to pursue expansionary fiscal policy, they may cut the higher rate of income tax (45% on income over £150,000). However, the mpc is likely to be low at this income level. However, if the income tax threshold is increased, there is likely to be a greater economic stimulus because, at those income levels, the MPC is higher.

See: best form of economic stimulus

The marginal propensity to save (MPS) = the amount of extra income that is saved.

In a closed economy (without taxes). The mpc + mps = 1.

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