The MPC formula: definition, how to calculate and FAQs

By Indeed Editorial Team

Published 6 July 2022

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Economists, analysts and policymakers use various formulas to inform their work and decision making, including the MPC. This calculation allows you to identify how much of a person's additional income they're going to spend and how much they're going to save. If you're interested in economics and decision making, understanding MPC and how it works can be quite useful. In this article, we explain what MPC is, provide the MPC formula and how to calculate this, what its uses are and answer some frequently asked questions.

What is MPC?

MPC is an acronym that stands for marginal propensity to consume. British economist John Maynard Keynes first developed this formula in the early 20th century. This allows you to calculate how much a person or group of people is going to spend when their income increases. This is why it's marginal, as it refers to a change in income rather than the total amount. The assumption is that when people receive more income, they're typically going to spend a portion of it on goods and services, and then save the rest or otherwise invest it.

Although calculating marginal propensity to consume (MPC) requires data that you've already gathered, you can use it to inform decision making. For example, if you've observed that consumers spend 60% of their additional income and that this pattern is mostly stable over time, you can assume that further increases to their income are going to result in similar behaviour. If you're working as an economist or analyst, being able to determine this can be useful for research or advising policymakers.

Related: How to calculate marginal benefit (and why it's useful)

How to calculate the MPC formula

Knowing the MPC formula means that you can make this calculation and derive insights from its results. As long as you have the relevant information, this is quite an easy formula to implement, as it only requires some division. You can then start to derive insights from this. The formula and how you can calculate it are as follows:

1. Locate instances of added disposable income

A basic requirement of the MPC is that disposable incomes have increased. Disposable income is what's left over after taxes and national insurance payments. There are two ways that this can happen, such as either you receive higher pay from your job or the government lower the taxes. In both cases, you're going to have more disposable income. It's therefore quite difficult to find relevant data for MPC if average incomes have been stagnant for some time or even declined. Here, you'd look for specific instances where incomes have actually increased, which typically means more limited examples and in-depth research.

Related: Research skills: definition and examples

2. Find the additional spending

Once you've got some instances of additional disposable income, you next want to find out how much of that amount they spent on goods and services. Since disposable income is what's left over after taxes and national insurance, this can mean any spending that you do with your income. This could include your buying choices regarding food at the supermarket, a new car or taking holidays.

3. Find the additional saving (optional)

The MPC formula assumes that there are two things that people do with added disposable income. For example, you spend it and save it, and the MPC helps you determine the ratio between these two priorities. There are also two ways of finding the figure for how much they save. The first way is if you simply have access to data that shows this information. The second way is to subtract the amount of additional spending from the marginal disposable income. This is based on the assumption that consumers simply save any money that isn't spent on goods and services.

This also means that you can use savings data to either find or verify the amount of marginal disposable income by using the same assumptions. For example, if you don't know someone's marginal income but you do know their marginal savings and expenditures, you can simply add the latter two together to find their marginal income. If you're using this to just check whether the data for marginal income is accurate, it can also allow you to test the validity of your assumptions or the data collection itself.

4. Calculate MPC with the formula

Once you've got the figures for both marginal spending and marginal income, you can calculate the marginal propensity to consume. You can do this for a single individual or for a larger group of people with an average. The formula for MPC is as follows:

MPC = marginal consumption / marginal income

The result is typically going to be a figure that's lower than 1. This is because people usually spend a portion of their added income on consumption. The higher this number is, the more likely they are to spend more when they receive additional marginal income. You can also multiply this figure by 100 to get a percentage.

Related: How to calculate percentages: a comprehensive guide

Uses of MPC

Calculating MPC is quite useful as it allows you to both analyse spending patterns and inform or understand policy decisions. Some of the key uses of MPC include the following:

Understanding buying behaviour

You can learn a lot about consumer behaviour from the MPC, especially when you organise your findings by income bracket. This is because people with different income levels typically have different spending patterns. For example, you might want to do some research for a company that sells to a specific part of the population. You could calculate the MPC for various income brackets, such as £20k to £30k, £30k to £40k and any other variables.

If you expect incomes to rise due to government policies and you know which bracket represents the company's customers, you can determine how much more they're going to spend. You can probably assume that they're not going to spend all of their marginal income on your goods, but it does tell you what the limit is and you can then adjust your own activities accordingly. Typically, the MPC is relatively higher among lower-income brackets.

Understanding confidence in the economy

This is based on a simple assumption, which is that people are more likely to spend if they believe that the economy is healthy and that they have little to worry about. If people expect economic hardship, they're more likely to save. This can become more pronounced among higher income brackets, as they're typically more likely to save or invest a significant amount of their disposable incomes. For instance, if the MPC value keeps dropping over time despite no decreases in disposable income, this could indicate that people are worried about the future and are saving up just in case.

Related: What are fiscal policies? (Plus how they work and types)

Understanding taxes

Policymakers might use MPC and other calculations to determine if certain policies are going to have the effect they want. If you want to understand why they chose a particular policy, formulas like MPC can help in this regard. For example, policymakers sometimes want to encourage an increase in consumer spending to stimulate the economy. One way of doing this is to increase the average disposable income, but first calculating the MPC can help them determine how effective this is going to be.

If they discover that the MPC is very low, such as 10%, then this means that people aren't going to spend much of their increased marginal income. Consequently, lowering taxes to increase marginal income isn't going to lead to a significant increase in consumer spending, and policymakers might therefore consider alternatives. If your job is to research and analyse policymaking, understanding MPC can help. For instance, if you're wondering why policymakers aren't dropping taxes despite wanting to increase consumer spending, finding a low average MPC figure could explain this.

Frequently asked questions about MPC

Below are some frequently asked questions about MPC, together with the respective answers for each:

Does MPC account for credit?

No. Marginal propensity to consume online includes additional marginal income, not spending that people make on credit. Moreover, people typically use credit exclusively for spending, as it'd be unusual to take out a loan just to save the money received.

What is MPS?

This is an acronym that stands for marginal propensity to save. It's effectively the opposite of the marginal propensity to consume. This is the proportion of increased marginal income that an individual saves instead of spending it on goods and services. You can calculate this by substituting the increase in spending with the increase in saving in the MPC formula, and then dividing that by the increased marginal income. The formula for MPS is as follows:

MPS = marginal saving / marginal income

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