Marginal Propensity to Consume

Marginal Propensity to Consume (MPC) is a key economic concept measuring the fraction of extra income spent on consumption. It characterizes consumer behavior, impacting the multiplier effect. MPC complements Marginal Propensity to Save (MPS) and plays a crucial role in influencing economic policies. It is calculated as the change in consumption divided by the change in income, impacting fiscal and monetary policies.

  • Consumer Behavior: MPC reflects how responsive individuals or households are to changes in income. A high MPC indicates that people tend to spend a significant portion of any increase in income, while a low MPC suggests they save more.
  • Multiplier Effect: MPC is a key component of the multiplier effect in economics. It shows how an initial change in spending can lead to a more significant overall impact on the economy. For example, if the MPC is 0.75, a $100 increase in income could lead to a $400 increase in overall economic activity.
  • Complement to Marginal Propensity to Save (MPS): MPC and MPS are complementary concepts. While MPC represents the portion of income spent, MPS represents the portion saved. Together, they sum up to one, reflecting the entire income.
  • Consumption-Driven Economies: Economies with a higher MPC tend to be more consumption-driven, as increased consumer spending fuels economic growth. Policymakers often aim to stimulate MPC through measures like tax cuts or direct cash transfers.
  • Impact on Economic Policies: Understanding MPC is essential for policymakers. It helps them design effective fiscal and monetary policies. For instance, during economic downturns, governments may implement policies to boost MPC to stimulate spending and revive economic activity.
  • Calculation: MPC is calculated as the change in consumption (ΔC) divided by the change in income (ΔY), expressed as MPC = ΔC / ΔY.
  • Real-World Application: MPC is used in economic forecasting, financial planning, and policy analysis. It helps businesses estimate future consumer demand and assists governments in formulating strategies to manage economic fluctuations.
  • Psychological Factors: MPC can be influenced by psychological factors such as consumer confidence, expectations about future income, and economic stability. Positive sentiment often leads to higher MPC.
  • Long-Term vs. Short-Term MPC: Economists distinguish between short-term and long-term MPC. Short-term MPC considers immediate responses to changes in income, while long-term MPC looks at sustained changes over time.
  • Global Economic Impact: Changes in MPC in one country can have spillover effects on the global economy, as it affects international trade, investment, and financial markets.

Key Highlights of Marginal Propensity to Consume (MPC):

  • Consumer Spending Indicator: MPC measures the proportion of additional income that individuals or households spend, making it a crucial indicator of consumer behavior.
  • Multiplier Effect: It plays a central role in the multiplier effect, showing how changes in spending can magnify the overall impact on the economy.
  • Complement to MPS: MPC and Marginal Propensity to Save (MPS) together sum up to one, reflecting the complete utilization of income between spending and saving.
  • Economic Stimulus: Policymakers use MPC to design economic stimulus measures, aiming to boost consumer spending during economic downturns.
  • Calculation: MPC is calculated as the change in consumption divided by the change in income, providing a precise numerical representation of spending behavior.
  • Real-World Application: MPC is applied in economic forecasting, financial planning, and policy formulation, influencing government decisions and business strategies.
  • Psychological Factors: Consumer sentiment and expectations can impact MPC, making it sensitive to psychological factors and economic stability.
  • Long-Term vs. Short-Term: Economists distinguish between short-term and long-term MPC, reflecting immediate responses and sustained changes in spending behavior.
  • Global Economic Implications: Changes in MPC in one country can ripple through the global economy, affecting international trade, investment, and financial markets.

Connected Financial Concepts

Circle of Competence

The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

What is a Moat

Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Buffet Indicator

The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Venture Capital

Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.

Foreign Direct Investment

Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country. 


Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.

Meme Investing

Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.

Retail Investing

Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.

Accredited Investor

Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.

Startup Valuation

Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.

Profit vs. Cash Flow

Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.


Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.

Balance Sheet

The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).

Income Statement

The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Cash Flow Statement

The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.

Capital Structure

The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).

Capital Expenditure

Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.

Financial Statements

Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.

Financial Modeling

Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.

Business Valuation

Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.

Financial Ratio



The Weighted Average Cost of Capital can also be defined as the cost of capital. That’s a rate – net of the weight of the equity and debt the company holds – that assesses how much it cost to that firm to get capital in the form of equity, debt or both. 

Financial Option

A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.

Profitability Framework

A profitability framework helps you assess the profitability of any company within a few minutes. It starts by looking at two simple variables (revenues and costs) and it drills down from there. This helps us identify in which part of the organization there is a profitability issue and strategize from there.

Triple Bottom Line

The Triple Bottom Line (TBL) is a theory that seeks to gauge the level of corporate social responsibility in business. Instead of a single bottom line associated with profit, the TBL theory argues that there should be two more: people, and the planet. By balancing people, planet, and profit, it’s possible to build a more sustainable business model and a circular firm.

Behavioral Finance

Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.

Connected Video Lectures

Read Next: BiasesBounded RationalityMandela EffectDunning-Kruger

Read Next: HeuristicsBiases.

Main Free Guides:

About The Author

Scroll to Top