Income and Consumption

The next step in understanding the vicious-circle relationship between income and expenditure is to look at the link from income to consumption. Common-sense suggests that there is a link -- the more income people have, the more they are willing to spend on consumption -- and Keynes certainly thought there was. Keynes suggested that there was a "psychological law" that any increase in income would result in an increase in consumption, but that the increase in consumption would be in less than a one-to-one proportion. In other words, if income increases by a dollar, consumption would increase by a fraction of a dollar. This fraction is the marginal propensity to consume.

Marginal Propensity to Consume -- abbreviation MPC: From one additional dollar of income (after taxes), the Marginal Propensity to Consume is the fraction of the dollar that is spent on consumption. (The rest is saved).

In other words, the consumption expenditure depends on the income. One of the simplest ways to express such a relation of dependency is as a linear function:

1. C = a + bY

where C is the consumption expenditure, (in billions of 1992 dollars, for example), Y the national income (in the same units) and a and b are constants. The constant b is the Marginal Propensity to Consume. An example with specific numbers would be

2. C = 200 + .9Y

where a would be 200 billion dollars and b would be .9. In this example, then, the Marginal Propensity to Consume is .9. This equation simply tells us (in ordinary language) that to get a first approximation to national consumption figures, we may multiply national income by nine-tenths and add 200 million dollars.

Remember, this is only an illustrative example! to get a reliable approximation, we would need to use some statistical methods and some real numbers.

Some Real Numbers