MPC and Spending Multiplier Discussion

 MPC and Spending Multiplier Discussion

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 MPC and Spending Multiplier Discussion

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describe what type of relationship (inverse or direct) exists between the marginal propensity to consume (MPC) and the spending multiplier? Explain why this relationship exists and give a hypothetical numerical example to help support your answer.

Keynes and Consumption

Consumption generally makes up about 70% of our economy, so consumption plays an important role in Keynes’ theories. Keynes envisioned a consumption function which showed a direct relationship between income and consumption. A function is similar to an equation. To say that income and consumption have a direct relationship is merely to say that as income rises, household spending rises. Keynes also said that as income increases, the resulting increase in consumption will be less than the increase in income. In other words, if someone receives a $100 raise, they will spend some of the raise and save the remainder, so that consumption will rise by less than $100. One more Keynesian concept before I introduce the consumption function, Keynes said that a portion of our consumption is independent from our level of income. In other words, even a person with no income must consume something in order to survive. Keynes termed this portion of consumption, autonomous consumption (Co). The general formula for the consumption function is:

C = Co + MPC?Y

(Note that in economics “Y” is the abbreviation for income)

MPC stands for marginal propensity to consume. This is a Keynesian variable which measures the portion of a change in income that is spent. The formula for deriving an economy’s MPC is:

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