What is the marginal propensity to consume (MPC) and why is it important in predicting consumer behavior?

Question

What will be an ideal response?

Answer 1

The marginal propensity to consume is the ratio of the change in consumption spending to the change in disposable income. The value of the MPC typically is less than one because when consumers receive an increase in income, their spending does not increase as much as income. For the United States, statistical estimates yield an MPC of approximately 0.95. If one knows the MPC, then predictions can be made of how much consumer spending will increase when disposable income increases by a certain amount. This is especially useful with regard to tax changes. If the federal government intends to increase aggregate demand through decreasing taxes, then knowing the MPC is necessary. For example, if the desired increase in consumer spending is $475 million and the MPC is 0.95, then taxes must be reduced by $500 million.