What is mpc essentials
The marginal propensity to save (MPS) = the amount of extra income that is saved. See: best form of economic stimulus Marginal propensity to save However, if the income tax threshold is increased, there is likely to be a greater economic stimulus because, at those income levels, the MPC is higher. However, the mpc is likely to be low at this income level. If the government wished to pursue expansionary fiscal policy, they may cut the higher rate of income tax (45% on income over £150,000). One important issue regarding MPC is the impact of tax cuts. Marginal propensity to consume and tax cuts If the marginal propensity to consume is 0, there will be no multiplier effect.įor example, if the government pursues expansionary fiscal policy (higher G) but consumer confidence is very low, then there will be a high propensity to save and a low marginal propensity to consume this will limit the effectiveness of fiscal policy because the injection will lead to only limited increases in spending and aggregate demand. The higher the MPC, the greater the multiplier effect will be. The marginal propensity to consume will determine the size of the multiplier. This is because the initial injection leads to knock on effects and further rounds of spending. government spending or investment) can lead to a bigger final increase in real GDP. The multiplier effect states that an injection into the circular flow (e.g. Marginal propensity to consume and the multiplier These three withdrawals can limit the marginal propensity to consume.
If income increases £10, in certain circumstances, they may increase spending by £11 – they finance this extra spending by borrowing. It is possible that consumers could have a marginal propensity to consume of greater than. Marginal propensity to consume greater than one expect unemployment/recession) then they will tend to delay spending decisions and there will be a low MPC. If confidence is high, this will encourage people to spend. A higher interest rate may encourage saving rather than consumption however, the effect is fairly limited because higher interest rates also increase income from saving, reducing the need to save. However, if they gain a permanent increase in income, they may have greater confidence to spend it. If people receive a bonus, then they may be more inclined to save this temporary rise in income. However, at higher income levels, people tend to have a greater preference to save because they have most goods they need already. At low-income levels, an increase in income is likely to see a high marginal propensity to consume this is because people on low incomes have many goods/services they need to buy. The average propensity to consume = consumption / income Factors that determine the marginal propensity to consume (MPC) The marginal propensity to consume can also be shown by the slope of the consumption function:
The marginal propensity to consume measures the change in consumption/change in disposable income The MPC will invariably be between 0 and 1.