Marginal Propensity to Consume: How Much of New Income Is Spent

Nobody spends every extra dollar. Give a household $100 more a month and some of it goes to groceries, a dinner out or a car payment, and some of it sits in a savings account or pays down a card. The split between those two piles, measured at the margin, is the idea John Maynard Keynes put at the center of his account of how spending moves an economy, and it still sits under most of the arguments about what a stimulus program will do.

A worked example

Say the marginal propensity to consume is 0.8. Then $80 of every extra $100 of income is spent and $20 is saved.

That spending is somebody else’s income. The shop owner who receives the $80 spends 80% of it, which is $64, and the chain keeps running with each round smaller than the last.

A tax cut or a payment to households works slightly differently. The first $100 lands as income, and only $80 of it is spent in round one, so the same chain starts one step later and the textbook total of spending comes to $400, four times the payment. Both versions use the same MPC.

The formula is very sensitive to the input. At an MPC of 0.5 the multiplier is 1 / 0.5 = 2, and at 0.9 it is 1 / 0.1 = 10. Small changes in the assumed share spent swing the answer enormously, which is one reason forecasts of a stimulus program’s effect can differ by a wide margin even when the forecasters agree on the size of the program and on how quickly the money goes out. Check the assumption first.

Why the real number is smaller

The formula is a simplification. Taxes take a share of each round of income before anyone can spend it. Some of the spending buys imports, so the next round of income arrives abroad. People save more when they expect the money to be a one-off, or when they are nervous about their jobs. Each of those leaks shrinks the multiplier, and estimates for real economies vary widely by the kind of payment, who receives it and where the economy stands in the cycle.

Where it shows up

No release publishes the MPC as a number. You see it indirectly. The monthly report on personal income and spending shows how outlays moved against income, and after a tax change or a payment program you can watch whether the extra income went out as spending or piled up as saving. Retail sales and company revenue reports carry the second-round effects later.

For an investor, the link runs through revenue. A company that sells to households lives on that spending. If a hypothetical $50 billion of tax relief reaches households who spend 80 cents of each dollar, first-round spending is $40 billion; if they spend 40 cents, it’s $20 billion, and an analyst’s forecast for a retailer’s next two quarters can hinge on which of those numbers turns out closer.

What people get wrong

• Confusing the MPC with the saving rate. One is marginal, the other average.
• Assuming the MPC is the same for everyone. Households with little cash tend to spend more of each new dollar.
• Quoting the textbook multiplier as a forecast.
• Forgetting that the effect runs in reverse, which matters in a downturn: when incomes fall, spending falls by the MPC times the loss, and each round of lost income cuts the next, the mechanism behind many accounts of how a recession spreads and who decides one has started.

Related terms

The marginal propensity to save is one minus the MPC. The marginal tax rate decides how much of each extra dollar of pay is left to spend in the first place. Fiscal policy leans on the MPC more than monetary policy does, a split covered in monetary vs fiscal policy, and stagflation, rising prices with stalled growth, is the setting where extra spending can feed inflation more than output.