Suppose MPC is 0.8 initally. Households then change their behavior so the MPC falls to 0.75. What happens to aggregate expenditures? Why?

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Posted on (Answer #1)

If the MPC declines from .8 to .75, the aggregate expenditures will decline.  This is because people will be spending less on consumption and will instead be saving their money.

The MPC is the marginal propensity to consume.  If the MPC is high, people will spend more of every dollar that they earn in marginal income.  If it is low, they spend less of each dollar and save more.  If the MPC is .8, consumers will spend 80 cents from each marginal dollar that they earn.  If the MPC drops to 75 cents, they will spend only 75 cents of each dollar.

If people save more and consume less, the amount of “induced consumption” will drop.  This will mean that there will be less economic activity, all other things being equal.  Thus, an increase in the MPC will mean that consumption will drop and aggregate expenditures will drop as well.


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