What is MPC Formula (Marginal Propensity To Consume)?
The formula for marginal propensity to consume (MPC) refers to the increase in consumer spending owing to the increase in disposable incomeDisposable IncomeDisposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes.read more. The MPC formula is derived by dividing the change in consumer spending (ΔC) by the change in disposable income (ΔI).
MPC formula is represented as,
or
Marginal Propensity to Consume formula = ΔC / ΔI
Further, the MPC formula can be elaborated into
Marginal Propensity to Consume formula = (C1 – C0) / (I1 – I0),
where,
- C0 = Initial consumer spending
- C1 = Final consumer spending
- I0 = Initial disposable income
- I1 = Final disposable income
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For eg:
Source: Marginal Propensity To Consume (MPC) Formula (wallstreetmojo.com)
Explanation of the MPC Formula
The formula for marginal propensity to consume can be derived by using the following steps:
- Identify I0 and C0 which are the initial disposable income and initial consumer spending respectively. Then note the final disposable income and the final consumer spending which are denoted by I1 and C1 respectively.
- Now work out the numerator of the formula which represents the change in consumer spending. It is arrived at by deducting the initial consumption quantity from the final consumption quantity.
Change in consumer spending, ΔC = C1 – C0 - Now work out the denominator of the formula which represents the change in disposable income. It is arrived at by deducting the initial disposable income from the final disposable income.
Change in disposable income, ΔI = I1 – I0 - Finally, the MPC formula is calculated by dividing the change in consumer spending (step 2) by change in disposable income (step 3) as shown below.
Marginal Propensity to Consume formula = Change in Consumer spending / Change in Income
Marginal Propensity to Consume formula = (C1 – C0) / (I1 – I0)
Examples of MPC Formula (with Excel Template)
Let’s see some simple to advanced examples to understand the calculation MPC formula better.
Marginal Propensity to Consume Formula – Example#1
Let us take the example of vacation expense of the employees of a particular company. Now let us assume that there is an increment of $160 given to all the employees across the organization due to the excellent business performance of the company. Due to the recent hike, the expense of an average employee for a yearly vacation trip went up by $200. Calcualte the marginal propensity to consume for an average employee of the organisation.
- Given, Change in consumer spending = $160
- Change in disposable income = $200
Below table shows data for calculation of marginal propensity to consume for an average employee of the organisation
Using the formula the marginal propensity to consume can be calculated as,
MPC formula = Change in consumer spending / Change in disposable income
Marginal propensity to consume = $160 / $200
Marginal propensity to consume for an average employee of the organisation= 0.80
Therefore, there is an increase of 80 cents in vacation expenditure for a dollar increase in income.
Marginal Propensity to Consume Formula – Example#2
Let us assume that there is a shop near Jack’s office which sells soft drinks. Jack is one of the biggest customers of the shop and consumes 30 litres of soft drinks every month. Now in the current month, he got a fat paycheck since he achieved the monthly target. His monthly payout went up from usual $300 to $400. Consequently, his soft drinks purchase also increased to 35 litres this month. The soft drink costs $5 per litre. Determine the marginal propensity to consume for Jack.
- C0 = 30 * $5 = $150,
- C1 = 35 * $5 = $175,
- I0 = $300 and
- I1 = $400
The following is data for calculation of marginal propensity to consume for Jack
Therefore, the marginal propensity to consume calculation for Jack is as below,
MPC formula = ($175 – $150) / ($400 – $300)
Marginal propensity to consume = $25 / $100
Marginal propensity to consume = 0.25
Therefore, there is an increase of 25 cents in soft drink consumption for a dollar increase in Jack’s disposable income.
Relevance and Use of MPC Formula
The MPC formula is one of the easiest economic formulae that is in use. If there is an increase in the disposable income then some of the extra money is spent. Simply divide the increase in consumer spending by the increase in disposable income and then the ratio of marginal propensity to consume is ready. The ratio normally falls in the range of zero and one which means that incremental income can either be entirely saved or partially consumed. However, there might be instances where the marginal propensity to consume can have value either greater than one.
If the marginal propensity to consume is greater than one, then it indicates that the change in income level has resulted in a relatively larger change in the consumption of the particular good. Such a correlation is a characteristic of goods with the price elasticity of demand greater than one such as luxury items.
If the marginal propensity to consume is equal to one, then it indicates that the change in income level has resulted in exactly the same change in the consumption of the good. Such a correlation can be seen for goods with the price elasticity of demand equal to one.
If the marginal propensity to consume is less than one, then it indicates the change in income levels has resulted in a relatively smaller change in the consumption of the good. Such a correlation can be seen for goods with the price elasticity of demand less than one.
If the marginal propensity to consume is equal to zero, then it indicates the change in income levels does not change the consumption of the good. Such correlation is applicable for goods with a price elasticity of demand of zero.
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This has been a guide to MPC Formula. Here we discuss how to calculate Marginal Propensity to Consume using practical examples along with downloadable excel templates. You may learn more about Financial Analysis from the following articles –
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