MPC, the marginal propensity to consume, what it means how it works -, Learning Economics... Solved!


MPC, the marginal propensity to consume, what it means how it works

The MPC, or marginal propensity to consume, is a number that will generally range from 0 and 1.  What it means is that for every dollar given to an individual (maybe income), how much of it are they going to spend?  The equation below shows mathematically what this means, MPC is equal to the derivative of consumption over income.  This basically says that MPC answers the question, how much does consumption change, given a change in income.  For most introductory class, the dY is assumed to be 1, which is why MPC is usually between 0 and 1.
If the MPC is .8, a common example, then 80 cents of every dollar is going to be spent by the individual.  Also, 20 cents is going to be saved (the rest has to go somewhere).  Where this comes into play, is through the use of the money multiplier:

For example, if the MPC is .8, and the government increases spending by say, $10, what is the total amount of money that gets injected into the economy?
The answer is $10/(1-.8) or $10/.2, or $50.  So if the MPC is .8, and $10 enters the economy, the total amount spent in the economy grows by $50.  Why?

The reason is because the money doesn't stop being used after the first payment.  Think of a construction worker getting paid by the government to build a government office.  If he gets $10 from the government, and his MPC is .8, then he spends $8 at the store that night.  The person at the store now has $8 more than before, and will spend .8 of it, or $6.4.  The place he spends this $6.4 will then spend .8 of it and so on and so on until the transactions asymptotically approach 0.  At this point, there will be $50 more dollars in the economy.