How to calculate the marginal propensity to consume?
The standard formula for calculating the marginal propensity to consume, or MPC, is marginal consumption divided by marginal income. This is sometimes expressed as
MPVS=mYesmVSor:mVS=Marginal consumptionmYes=Marginal income
In layman terminology, this means that the MPC is equal to the percentage of new income spent on consumption rather than saved.
For example, if Tom receives $ 1 in new disposable income and spends 75 cents, his GPA is 0.75 or 75%. If all new income is spent or saved, then Tom must also have a marginal propensity to save, or MPS, of 0.25 or 25%.
Origins of the marginal propensity to consume
The famous British economist John Maynard Keynes officially introduced the concept of MPC in his “General Theory of Employment, Interest and Money” in 1936. Keynes argued that any new income must either be spent, as for consumption, be invested, as for consumption. savings.
During the Depression of the 1930s, Keynes realized that the classical thought that supply creates its own demand does not always work. He noted that during the Great Depression, the main problem was the lack of aggregate demand. He also noted that government spending could increase aggregate demand and that this fiscal stimulus would create a “multiplier effect” through increased consumer demand. To summarize these concepts, note that a simple closed economy that aggregates demand can be represented by the following expression:
Yes=VS+I+gor:Yes=Global demandVS=Consumer demandI=Investment requestg=Government request
Keynes also introduced the concept of consumption function:
C = mA
Where m = the marginal propensity to consume (MPC) with m
In this context, we can express the aggregate demand in the form:
Y = C + I + G = mY + I + G
Solving this expression for Y gives:
Y = (I + G) / (1-m)
Where the term 1 / (1-m) is the Keynesian “multiplier” of income. In our example with m = .75 the multiplier is
1 / (1-.75) = 4
If Y decreases due to a problem with investment spending (i.e. business confidence), the government can intervene to increase aggregate demand by increasing G. If m = 0.75 then the multiplier is 4 indicating a $ 1 increase in G, all other things being equal, this would result in an income increase of $ 4 in Y.
This was Keynes’ contribution to economic thought at the time and was fundamental then and today in the role of fiscal policy in returning the economy to full employment.
In terms of importance, there is perhaps not a more underrated part of Keynes’ theory than MPC. Indeed, Keynes’ famous investment multiplier assumes that MPC has a strict positive correlation with increasing level of investment activity.
Despite the relative simplicity of Keynes’ argument on identifying the MPC, macroeconomists have not been able to develop a universally accepted method for measuring the MPC in the real economy. Much of the problem is that new income is seen as a cause and an effect on the relationship between consumption, investment and new economic activity, which generates new income.