Consumption, Saving, Investment, and the Multiplier ❮ 95The marginal propensity to consume (MPC) is the change in consumption caused
by a change in disposable income. Another way to think about it is the slope of the con-
sumption function:
MPC = DC/DDI = Slope of consumption function
Using Table 8.1, we see that for every additional $100 of DI, C increases by $80, so
the MPC = .80.
The marginal propensity to save (MPS) is the change in saving caused by a change
in disposable income. Another way to think about it is the slope of the saving function:
MPS = DS/DDI = Slope of saving function
Using Table 8.1, we can see that for every additional $100 of DI, S increases by $20,
so the MPS = .20.
There is a nice relationship between the MPC and the MPS. For every additional dollar
not consumed, it is saved. So if the consumer gains $100 in disposable income, he increases
his consumption by $80 and increases saving by $20. In other words, MPC + MPS = 1.
If you know one, you can find the other.• MPC = DC/DDI = Constant slope of consumption function
• MPS = DS/DDI = Constant slope of saving function
• MPC + MPS = 1Changes in Consumption and Saving
A change in disposable income causes a movement along the consumption and savings
functions. Economists typically recognize four external determinants of household con-
sumption and saving that shift the functions upward or downward.Determinants of Consumption and Saving
• Wealth. When the value of accumulated wealth increases, consumption functions shift
upward, and the saving function shifts downward, because households can sell stock or
other assets to consume more goods at their current level of disposable income.
• Expectations. Uncertainty or a low expectation about future income usually prompts
a household to decrease consumption and increase saving. An expectation of a higher
future price level spurs higher consumption right now and less saving.
• Household debt. Households can increase consumption with borrowing, or debt.
However, as households accumulate more and more debt, they need to use more and
more disposable income to pay off the debt, and thus decrease consumption.
• Taxes and transfers. A change in taxes impacts both consumption and saving in the same
direction. If the government increases taxes, households see both consumption and
saving decrease because more of their gross income is sent to the government. On the
other hand, an increase in government transfer payments increases both consumption
and saving functions. In the case of taxes and transfers, consumption and saving func-
tions shift in the same way.
An upward shift in consumption tells us that at all levels of disposable income, con-
sumption is greater (CHigh). If consumption is greater at all levels of disposable income,
saving must be lower (SLow), and vice versa. The only exception is the case of taxes and trans-
fers described above. Figures 8.3 and 8.4 illustrate these simultaneous shifts in the opposite
directions.TIP