Marginal propensity to consume (MPC) is the slope of the Keynesian AE curve. Usi
ID: 1198140 • Letter: M
Question
Marginal propensity to consume (MPC) is the slope of the Keynesian AE curve. Using an equation and words, describe the relationship between MPC and the Keynesian spending multiplier. Marginal propensity to consume (MPC) is the slope of the Keynesian AE curve. Using an equation and words, describe the relationship between MPC and the Keynesian spending multiplier. Marginal propensity to consume (MPC) is the slope of the Keynesian AE curve. Using an equation and words, describe the relationship between MPC and the Keynesian spending multiplier.Explanation / Answer
The definition of MPC in basic Keynesian analysis is given as follows:
MPC = C / Y
It is the fraction of any additional income that is spent on consumption. If it is a fraction, then it is less than 1.0
In this context, consumption means household consumption, non-profit organisation consumption and government consumption (the everyday costs of running the government as if it were a household.)
If we rearrange this expression, we get this:
Y = C / MPC
This says that an autonomous increase in consumption will lead to a multiplier effect on the increase in income. We are dividing the increase in consumption by a fractional value, so the result will exceed 1.0
Example: Let MPC = 0.75 That is, 75% of extra income is allocated to consumption.
If consumption can be raised by $ 1million, from savings or borrowing or by creation of additional purchasing power through monetary policy, then income will eventually rise to $ 1.33million as follows:
Y = C / MPC = 1million / 0.75 = 1million x 4/3 = 1.33million
So, the multiplier is defined as follows:
"spending" multiplier = 1 / MPC
and has the value 1.333 in our example.