Question

What type of relationship exists between the marginal propensity to consume (MPC) and the multiplier? Explain why this relationship exists. Give a hypothetical numerical example to help support your answer.

Answer 1

The marginal propensity to consume and the multiplier have the direct relationship because the multiplier depends on the value of the MPC

MPC is the aggregate raise in income used to consume goods

An increase in MPC will increase the Multiplier.

MPC=Change in consumption/Change in income

For example- when the consumption increases by 50% for each $1 raise in income

then, MPC =0.50/1=0.5

In this case,Multiplier will be 1/1-MPC = 1/1-0.5 = 2

When the MPC increases to 80% then the multiplier will be 1/1-0.8 = 5 so the Multiplier will increase with an increase in the MPC

The MPC always varies with a change in income because when the income rises the consumption on goods rises and so the multiplier will increase with an increase in MPC and will decrease with a decrease in MPC or when the people would want to save more i.e when the marginal propensity to save is higher than the marginal propensity to consume.