Unit 3: Marginal Propensity to Consume (MPC)

Marginal Propensity to Consume (MPC)

Definition: The fraction of any change in disposable income that is consumed.

• MPC = Change in Consumption / Change in Disposable Income
• MPC = Change in Savings / Change in Disposable Income

Marginal Propensities

• MPC + MPS = 1
• .: MPC = 1 - MPC
• .: MPS = 1 - MPC
• Remember that people do two things with their disposable income, consume it or save it !

The Spending Multiplier Effect

Definition: An initial change in spending (C, IG, G, Xn) causes a larger change in any aggregate  Spending, or Aggregate Demand (AD).

• Multiplier = Change in AD / Change in Spending
• Multiplier = Change in AD / Change in C, I, G, or Xn

Calculating the Spending Multiplier

Definition: The Spending Multiplier can be calculated from the MPC or the MPS.

• Spending Multiplier = 1 / 1 - MPC or 1 / MPS
• Spending Multipliers are (+) when there is an increase spending and (-) when there is a decrease in spending.

Calculating the Tax Multiplier

Definition: When the government taxes, the multiplier works increase

• Why?
• Because now $ is leaving the circular flow.
• Tax Multiplier ( note: it’s negative)
• Tax Multiplier = -MPC / 1 - MPC or -MPC / MPS
• If there is a tax -CUT, then the multiplier is (+), because there is now more $ in the circular flow.