Marginal propensity to consume

The marginal propensity to consume is defined as the ratio of the change in consumption to the change in disposable income that brought it about. It is a slope of the consumption function, which relates total consumption to income. For example, if a household receives an extra $1,000 and spends $800 of it, the MPC is 0.8. The complement, the marginal propensity to save (MPS), equals 1 − MPC. In empirical work, MPC is estimated using household surveys or macroeconomic time series, often controlling for wealth, expectations, and demographic factors. Estimates for the United States typically range from 0.5 to 0.9, depending on the income group and the type of income change (e.g., tax rebates vs. permanent income changes).¹

In Keynesian economics, the MPC determines the magnitude of the fiscal multiplier: an initial increase in autonomous spending (such as government investment) leads to a chain of consumption spending, each round being a fraction (MPC) of the previous. The simple multiplier is 1/(1−MPC), so an MPC of 0.8 yields a multiplier of 5. This mechanism underlies the rationale for countercyclical fiscal policy. However, the multiplier is smaller in open economies (due to imports) and when taxes or price adjustments dampen the effect. New classical and real business cycle models often assume a lower MPC because households smooth consumption over time, but recent empirical studies using lottery winners or tax rebates find substantial MPCs, especially for liquidity-constrained households.²

Empirical research shows that the MPC varies significantly across households. Lower-income and younger households tend to have higher MPCs because they are more likely to be credit-constrained and have less buffer savings. For instance, a study of the 2008 U.S. economic stimulus payments found that households with low liquid wealth spent about 60% of the payment, while high-wealth households spent almost none.³ Similarly, natural experiments with lottery winners in Sweden reveal an average MPC of about 0.1 for large windfalls, but much higher for small windfalls, indicating that the MPC is not constant but declines with income and wealth. This heterogeneity has important implications for the design of targeted fiscal policies, as transfers to low-income groups are more effective in stimulating demand.⁴

Beyond the standard textbook treatment, several nuances are often overlooked. First, the MPC is not a fixed parameter but varies with the type of income change: temporary tax rebates yield lower MPCs than permanent income changes, as predicted by the permanent income hypothesis. Second, the MPC can exceed 1 for households in severe financial distress, as they may increase consumption by borrowing against future income. Third, the concept has been applied to other domains, such as the marginal propensity to consume out of wealth (housing or stock market gains), which is typically smaller than out of income. Fourth, historical estimates for the Great Depression suggest that a high MPC (around 0.7) contributed to the severity of the downturn, as falling income led to disproportionate cuts in consumption. Finally, behavioral economists have shown that the framing of income (e.g., as a bonus vs. regular salary) can affect the MPC, a phenomenon not captured in traditional models.⁵

Disposable income

Income after taxes and transfers, available for consumption or saving.

Multiplier effect

The magnified impact of an initial spending change on aggregate output.

Marginal propensity to save

The fraction of an additional unit of income that is saved; equals 1 − MPC.

Consumption function

A mathematical relationship between consumption and income.