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Marginal Propensity to Consume - MPC

Definition: Marginal Propensity to Consume, or MPC, is an economic calculation that measures the amout of additional income consumers are willing to spend on goods and services rather than saving it. In other words, it shows what proportion of additional money consumers earn will be spent versus what portion they will save.

This economic concept is a little difficult to understand because thereís no easy way to describe it without an example. For instance, say you find dollar on the side of the road today. What will you do with that extra dollar that is in addition to your regular salary? Will you save it or will you spend it on goods? Thatís what MPC measures. It measures the percentage of that extra dollar that you will spend rather than saving.

This is an important concept for the government and the FED when they set monetary policies aimed at increasing consumer spending like expansionary policies. If the FED understands the MPC of the average consumer, it can drastically affect overall consumption by increasing or decreasing public spending.

The marginal propensity to consume formula is calculated by dividing the change in spending by the change in income.

Letís look at an example of how this works.

Example

Matt is the head engineer at Tonda, and up until now he has been making $50,000 per year. Since the economy is booming and Tonda is selling more cars, Matt gets a bonus this year of $10,000.

Now he has $10,000 extra that he can either save or spend. Letís say that he spending $3,000 on goods and services and decides to save the rest. Mattís MPC would be .3. Meaning that he spent 30 percent of his additional income on goods and services.

Letís take this example a step further and assume that Matt got another bonus six months later of $5,000. If Mattís MPC stayed the same he would spend $1,500 of this second bonus.

Typically, as income increases consumers spend a greater dollar amount on goods and services but a lesser percentage of overall income. This is true with Mattís example as well.

The FED analyzes consumer habits like Mattís to come up with an average of their MPC and calculate a multiplier. This will give them an estimation of the economic output additional spending might spur.

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