Sunday, December 2, 2012

MPC: Marginal Propensity to Consume

From the Wikipedia article:

The proportion of the disposable income which individuals desire to spend on consumption is known as propensity to consume. MPC is the proportion of additional income that an individual desires to consume.

Oh... Okay. But that is not the interesting thing about the MPC. The interesting thing is that as income goes up, more of it gets saved. Saving increases faster than income, and spending increases more slowly. The propensity to save goes up more than income. The propensity to consume goes up less.

And that is exactly what Waliapreeti's graph in the Wikipedia article shows:

Graph #1: Consumption Spending goes up Less than DisposableIncome.

As income goes up, more of it is saved. As income goes down, less of it is saved. If we are saving less, the MPC says, our income is probably going down.

So now: Here's a graph of the U.S. personal saving rate. (As FRED describes it, "Personal saving as a percentage of disposable personal income".)

Graph #2: Personal Saving as a percentage of Disposable Personal Income
A pretty much straight-line decline in saving from the mid-1970s to the recession of 2009. The MPC tells us what we already know: Income was going down all that time.

But then, with the recession of 2009, the saving rate suddenly jumped up. So based on the principle of the Marginal Propensity to Consume, did income suddenly jump up sharply? That upward spike during the 2009 recession, that's what it suggests.

Or maybe -- just maybe -- there was a sudden change in the Marginal Propensity to Consume. Yeah, that's it. A sudden change in the MPC. And what does that tell us?

It tells us that the straight-line downward trend of saving and income was not a sustainable policy.


Luke Smith said...

The US has had far more investment than savings in that time period from the 1970s to the Great Recession. A lot of people sound off on the US deficit as a sign of declining savings. If savings is equal to income minus consumption and taxes then correct, either consumption went down or taxes went down.

But taxes and consumption went down during the recession, as did income. I think this is why Keynesians argue for government deficits during and after recessions, is that it should help offset losses in household consumption.

The Arthurian said...

Ha! When you put it like that, you make the business cycle sound like some sort of pump that transfers consumption to the government sector.

Luke, how would you measure investment and savings (from the 1970s to the Great Recession, or whenever)... What FRED series, I guess I'm asking, or what data?

Luke Smith said...

I am currently breaking down GDP by component to get a better idea. I have focused so far on PCE and Gross Domestic Investment.

I have also used the idea that investment is equal to savings minus net exports, so I am focusing also on Net Exports.

There are some other GDP components I will get around to and post about as well.