Marginal Propensity to Consume (MPC)
Marginal Propensity to Consume (MPC) is an economics concept that refers to the proportion of change in income spent by a consumer for goods and services instead of saving it on the increase in disposable income. It explains the amount of extra income a consumer gets and spends it on goods or services and not on saving (Carroll, Christopher, et al 6) Marginal propensity to consume is a Keynesian macroeconomic theory component and is calculated using the below formulae:
MPC = Change in consumption/Change in disposable income
For example, if a person gets an extra $1000 income and spends $750 to buy goods and services, then the person’s marginal propensity to consume is $750/1000 = 0.75. MPC is invariable and is always between 0 and 1. However, in rare circumstances, MPC can be negative when the extra spending is financed by borrowing.
The Determinants of MPC
The marginal propensity to consume is determined by many factors, including income levels, tax rates, interest rates, consumers’ confidence, and the nature of income increase. On income levels, people with a low-income level are more likely to spend more when their income levels rise because they have many goods and services to acquire compared to people with a high level of income how have almost everything they need; hence can easily save any extra income they get (Arrondel, Pierre and Frédérique 21). On interest rates, a high-interest rate encourages savings while lower interest rates discourage savings hence more spending. On the nature of income increase, temporary income increase is more inclined to savings, while a permanent increase in income is inclined to consumption as one is confident of getting it periodically. Consumer confidence is also another determinant for the marginal propensity to consume for people with high confidence to income raise tend to spend more while those uncertain of income rise tend to save (Wang and Cai
38). Future economic conditions have an impact on marginal propensity in consumption as issues like expected recession and unemployment lead to low spending and high savings. In situations of economic shocks, there is uncertainty, fear, and doubt, which lead to low spending and high saving.
MPC during the Financial Crisis of 2007-2008
During the great recession of 2007-2008, it was characterized by financial shocks that lead to the lowest consumption ever recorded since 1945. There was a decline in spending, and it is estimated that every household’s consumption reduced to almost 12 quarters of its normal household consumption (Ganong and Pascal 33). Thus as all households reduced on their consumption relative to the income they received, so there was a low marginal propensity to consumption as any extra income was used for savings for the uncertain future and not for consumption. Due to the low consumption at national and household levels, the real gross domestic product (GDP) relatively fell from 2007 to the second quarter of 2019 when it started to recover. According to Aydin (61), the GDP went down by 5.5 percent, and it led to a high unemployment rate of between 5-9.5 percent. Personal consumption declined as people were facing uncertainty about the future of the economic system. Private investment was also affected as it was noted that there was a per capita fall of 21.1 percent between the fourth quarters of 2007 and the second quarter of 2009. The fall in personal consumption and private investment is explained by the uncertainty that led to low spending for goods and services.