Calculation of Marginal Propensity to Consume (MPC) in Economy: Meaning and Features!
The ratio of change in consumption (∆C) due to change in income (∆Y) is called marginal propensity to consume.
Marginal literally means additional (or incremental) and propensity to consume means desire to consume.
Thus, MPC is that part of additional income which is spent on additional consumption. In other words, it measures the ratio of change in consumption expenditure as a result of change in income. MPC is worked out by dividing the increment (or decrement) in consumption with the corresponding increment (or decrement) in income.
MPC = ∆C/∆Y
Where D (called delta) indicates ‘change in’ For instance, if income of a country Increases from Rs 5,000 crore to Rs 5,500 crore (i.e., by Rs 500 crore) and as a result, consumption expenditure goes up from? 4,000 crore to Rs 4,300 crore (i.e., by Rs 300 crore), then:
MPC= ∆C/∆Y = 300/500 = 3/5= 0.6
This shows that a rupee change in income causes a 0.6 rupee (or 60 paise) changes in consumption.
Features of MPC:
(i) MPC is always greater than zero (MPC > 0) but less than 1 (MPC < 1). The above example shows that with increase in income, consumption expenditure also increases (i.e., MPC > 0) but the entire increase in income is not spent on consumption (i.e., MPC < 1). Hence, the value of MPC always lies between 0 and 1.
It means 0 < MPC < 1. The reason is that incremental income can be either consumed or entirely saved. If entire incremental income is consumed, the change in consumption (∆C) will be equal to change in income (∆Y) making MPC = 1. In case the entire income is saved, change in consumption is zero meaning MPC = 0.
(ii) MPC falls with increase in income. As a person becomes richer, he tends to consume a smaller portion of increase in income.
(iii) MPC is assumed to be constant for a straight line consumption curve.
(iii) MPC, i.e., ∆C/∆Y is graphically the slope of consumption curve.
How does MPC affect level of income?
Consumption is the major component of aggregate demand. Mind, MPC is always greater than zero (MPC > 0) and less than 1 (MPC < 1) because additional consumption (∆C) is less than additional income (∆Y). Higher MPC implies increase in consumption demand. According to Keynes, ‘Demand creates its own supply. ‘Thus, higher MPC will lead to increase in production and the level of income whereas lower MPC will bring down the level of income.