Marginal Propensity to Consume (MPC)

Marginal Propensity to Consume (MPC)

The marginal propensity to consume (MPC) is the fraction of an additional unit of income that a household spends on consumption rather than saving. It is a fundamental concept in Keynesian economics used to analyze how changes in income affect consumer spending and, by extension, aggregate demand.

Definition and formula

MPC = ΔC / ΔY

• ΔC = change in consumption
• ΔY = change in income

Example: If a $500 bonus leads you to spend $400 and save $100, MPC = $400 / $500 = 0.8.

MPC ranges from 0 to 1 in simple models. An MPC of 0 means all additional income is saved; an MPC of 1 means all additional income is spent.

Relationship to saving

The marginal propensity to save (MPS) complements MPC:

MPC + MPS = 1

Using the example above, MPS = $100 / $500 = 0.2.

MPC and the multiplier effect

MPC determines the size of the Keynesian multiplier, which measures how initial increases in spending (for example, government stimulus or investment) propagate through the economy. A higher MPC means more of any income increase is spent immediately, producing larger subsequent rounds of consumption and a larger overall increase in aggregate demand.

Roughly, the simple spending multiplier is 1 / (1 − MPC). For instance, if MPC = 0.8, the multiplier ≈ 5.

Variation by income level

MPC is not constant across households or income groups:

• Lower-income households typically have higher MPCs because a larger share of additional income goes toward immediate needs.
• Higher-income households tend to have lower MPCs because basic consumption needs are already met and they are more likely to save additional income.

This variation matters for policy design: transfers or tax cuts targeted at lower-income groups usually stimulate consumption more per dollar than equivalent transfers to higher-income households.

Policy and practical implications

• Fiscal stimulus: Policymakers use estimates of MPC to predict the demand-side impact of tax cuts, direct payments, or public spending. Targeting recipients with higher MPCs increases short-term demand effects.
• Business planning: Firms and forecasters use MPC-related insights to anticipate consumer spending changes when incomes change (e.g., during wage growth or one-time bonuses).
• Personal finance: Knowing your own MPC can clarify how likely you are to convert extra income into spending versus savings, which can inform budgeting and saving strategies.

Key takeaways

• MPC measures the share of additional income that is spent rather than saved (MPC = ΔC / ΔY).
• MPC + MPS = 1.
• A higher MPC produces a larger multiplier and a stronger short-term boost to aggregate demand from fiscal stimulus.
• MPC varies by income: lower-income households tend to have higher MPCs.
• Understanding MPC helps both policymakers design effective stimulus and individuals make informed financial choices.