key term - Marginal Propensity to Consume (MPC)

Definition

The Marginal Propensity to Consume (MPC) is the fraction of an additional dollar of income that a consumer will spend on consumption. It represents the change in consumption spending resulting from a one-unit change in disposable income, holding all other factors constant.

5 Must Know Facts For Your Next Test

1. The MPC is a value between 0 and 1, where a higher MPC indicates a greater proportion of additional income will be spent on consumption.
2. The MPC is a key determinant of the size of the multiplier effect, which describes how an initial change in spending can lead to a larger change in total economic output.
3. A higher MPC leads to a larger multiplier effect, meaning that a given change in autonomous spending (e.g., government spending or investment) will have a greater impact on total output.
4. The MPC is influenced by factors such as consumer confidence, wealth, and expectations about future income and prices.
5. Shifts in the MPC can lead to changes in the slope of the aggregate demand curve, affecting the overall level of economic activity.

Review Questions

• Explain how the MPC relates to the consumption function and the multiplier effect.
  • The MPC is a key parameter in the consumption function, which describes the relationship between disposable income and consumption spending. A higher MPC means that a greater fraction of additional income will be spent on consumption rather than saved. This, in turn, leads to a larger multiplier effect, where a change in autonomous spending (such as government spending or investment) has a greater impact on total output and income. The size of the multiplier is inversely related to the MPC, with a higher MPC resulting in a larger multiplier.
• Describe how shifts in the MPC can affect the aggregate demand curve.
  • Changes in the MPC can lead to shifts in the aggregate demand curve. If the MPC increases, it means that consumers are spending a greater proportion of their additional income on consumption. This will result in a rightward shift of the aggregate demand curve, as the increase in consumption spending leads to a greater overall level of demand in the economy. Conversely, a decrease in the MPC will cause a leftward shift of the aggregate demand curve, as consumers are saving a larger fraction of their income and reducing their consumption spending.
• Analyze the potential factors that may influence the MPC and explain how changes in these factors could impact the overall economy.
  • The MPC can be influenced by a variety of factors, including consumer confidence, wealth, and expectations about future income and prices. For example, if consumers become more optimistic about their future income prospects, they may be willing to spend a greater proportion of their current income, leading to an increase in the MPC. This would result in a larger multiplier effect and a rightward shift of the aggregate demand curve, potentially stimulating economic growth. Conversely, if consumers become more pessimistic and increase their saving, the MPC would decrease, leading to a smaller multiplier effect and a leftward shift of the aggregate demand curve, which could slow down economic activity.

Related terms

Aggregate Demand (AD):

Aggregate Demand is the total demand for all goods and services in an economy at a given time and price level.

Consumption Function:

The consumption function is an economic equation that shows the relationship between consumer spending and disposable income.

Multiplier Effect:

The multiplier effect is the increase in final income arising from any new injection of spending, and is calculated as 1 / (1 - MPC).