The marginal propensity to consume (MPC) can best be defined as that fraction of
A real disposable income that is consumed.
B real disposable income that is not consumed.
C a change in real disposable income that is saved.
D a change in real disposable income that is spent.
The Correct Answer and Explanation is :
The correct answer is D: a change in real disposable income that is spent.
The marginal propensity to consume (MPC) refers to the proportion of an additional amount of disposable income that a household or individual spends on consumption rather than saving. Essentially, it quantifies how much more people will consume for each additional dollar of income they receive.
To break this down further:
- Disposable income is the amount of income available to individuals or households after taxes and transfers. It is essentially the income left for spending and saving.
- Marginal propensity to consume (MPC) is a measure of how much of each additional dollar of disposable income is spent on consumption. For example, if an individual’s disposable income increases by $1, and they spend 80 cents of that dollar, the MPC is 0.80.
- MPC’s Importance: The concept is central in Keynesian economics because it helps explain the relationship between income and consumption. The higher the MPC, the greater the impact an increase in income has on overall economic demand, as more of that income will be spent on goods and services, stimulating economic activity. Conversely, a lower MPC means individuals are more likely to save extra income rather than spend it, which can lead to a slower economic growth rate.
- Real-world Example: If the government provides a tax rebate or if wages rise, the MPC will indicate how much of that extra income is spent. A higher MPC would suggest that people are likely to spend the majority of this extra income, which could help boost economic growth. On the other hand, if the MPC is low, much of the increase in disposable income would be saved, which may not have as immediate an impact on the economy.
In summary, the MPC measures the change in consumption relative to the change in disposable income, which is why D is the correct definition.