Marginal Propensity to Consume & Multiplier Effect

Marginal Propensity to Consume & Multiplier Effect
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  • 0:04 Marginal Propensity to…
  • 0:43 Formula and Calculations
  • 1:25 Multiplier Effect
  • 2:23 Additional Formula and…
  • 3:05 Lesson Summary
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Lesson Transcript
Instructor: Brianna Whiting
Can you remember the last time you splurged and bought something you have always wanted? While that probably had an enjoyable effect on you, what were the effects of your spending on the economy? In this lesson, we will answer that question as we explore marginal propensity to consume.

Marginal Propensity to Consume (MPC)

We all would love the opportunity to receive extra money on our paychecks. But what would you do with that extra money? Would you buy new clothes? Would you go to a concert? Or perhaps you would buy the newest cell phone that was just released. While most of us have some sort of routine of what we pay each month with our paychecks, in the event that we do receive extra income, we must make a decision of what to do with that money.

In this lesson we will look at one choice, which is to spend the money on goods and services. How much of that extra money we spend is known as the marginal propensity to consume. In other words, when we receive extra money, the proportion of it that's spent rather than saved falls under marginal propensity to consume.

Formula and Calculations

Now that we know what marginal propensity to consume is, let's apply it to an example so that we can see how it's actually calculated.

Let's imagine that you receive a $600 bonus on your paycheck. After discussing it with your family, you decide to purchase a new couch in the amount of $400. This means you decide to consume $400 of your extra income. The remaining $200 is placed in a savings account. When we plug those numbers into an equation, we get the following:

MPC = change in consumption / change in income

MPC = $400 / $600 = 0.66

Thus, 66% of the extra income was used for consumption.

Multiplier Effect

Another important piece of the marginal propensity to consume is the multiplier effect. The multiplier effect is the term used when the final income increases due to additional spending. In basic terms, we can think of our economy's flow as a circle. When we spend money on goods and services, we inject it into the flow of the economy. This money then goes to the producer of those goods and services so that they can achieve an income and so that they can produce the goods and services we demand and want to purchase. When they produce the goods, they add them to the flow, and when we purchase them, we also add money back to the flow.

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