Marginal Propensity to Consume: How MPC Works

Marginal propensity to consume (MPC) is a macroeconomic calculation that measures how much more a person spends (or consumes) when their income increases. MPC is an element of Keynesian economic theory, proposed by John Maynard Keynes, which argues that the driving force of an economy is aggregate demand—the total spending for goods and services by the private sector and government. In the Keynesian economic model, total spending determines all economic outcomes, from production to employment rate. In Keynesian economics, demand is crucial—and often erratic.

The average propensity to consume (APC)—which calculates the average percentage of income that different households of varying income levels spend rather than save—is related to MPC. Lower-income households tend to have a higher MPC because the amount of money they spend on day-to-day expenses will typically represent a larger percentage of their income than high-income households, which are more likely to have extra fiscal reserves left over after a consumption cycle.

Economists can examine the marginal propensity to consume across households in different income brackets to assess economic inequality or government fiscal policy. The marginal propensity to consume shows how consumption increases with a marginal increase in wealth, which increases a person’s purchasing power. In turn, this increase in consumption means that there will be more money in circulation, and more economic activity and growth.

However, MPC can also reveal critical wealth gaps that can stunt a country’s economic growth. In low-income households, the propensity to consume with increased income is higher on average, as they need to spend the majority of their income on essential living expenses. Higher-income households tend to have lower MPC numbers, as they have more disposable income which they can choose to save or spend, as well as already having established liquid assets.

You can calculate MPC by dividing the change in consumption by the change in income.

The marginal propensity to consume formula looks like this: MPC = Change in Consumption / Change in Income

For example, if you receive a raise of $1,000, and you decide to spend $600 dollars of that raise, your marginal propensity to consume would be 600 / 1,000 = 0.6. The opposite of marginal propensity to consume is marginal propensity to save, which is the difference between the increase in income and the marginal propensity to consume. In this example, the marginal propensity to save would be 0.4.

The marginal propensity to consume helps economists and government officials plan monetary policy, allocate government spending, and assess wealth inequality. For example, when a country’s economy suffers drastically due to unforeseen circumstances, the government may issue additional income to all residents making below a certain income threshold as a way to stimulate economic growth and consumer spending. The government hopes residents will use the additional income to consume, banking on households with a high propensity to consume to stimulate economic activity. This theory, which suggests that additional spending leads to more economic activity, is a Keynesian concept called the multiplier effect.

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