What Is the Marginal Propensity to Invest (MPI)?
The marginal propensity to invest (MPI) is the ratio of change in investment to change in income. It shows how much of one additional unit of income will be used for investment purposes. Typically, people will only invest a portion of their income, and investment increases when income increases and vice versa, meaning that the MPI is a positive ratio between 0 and 1. The greater the MPI, the larger the proportion of additional income is invested rather than consumed.
- The marginal propensity to invest (MPI) is the proportion of an additional increment of income that is spent on investment.
- The MPI is one of a family of marginal rates devised and used by Keynesian economists to model the effects of changes in income and spending in the economy.
- The larger the MPI, the more of an addition to income gets invested.
- Spending directed toward investment, by the MPI, may have a multiplier effect that boosts the economy, but this effect might vary or possibly even be negative if crowding out occurs.
Understanding the Marginal Propensity to Invest (MPI)
Although John Maynard Keynes never explicitly used the term, the MPI originates from Keynesian economics. In Keynesian economics, a general principle states that whatever is not consumed is saved. Increases (or decreases) in income levels encourage individuals and businesses to do something with the amount of available money.
The MPI is one of several marginal rates that have been developed through Keynesian economics. Others include the marginal propensity to consume (MPC), the marginal propensity to save (MPS), and less well-known ones such as the marginal propensity for government purchases (MPG).
The MPI is calculated as MPI = ΔI/ΔY, meaning the change in value of the investment function (I) with respect to the change in value of the income function (Y). It is thus the slope of the investment line.
For example, if a $5 increase in income results in a $2 increase in investment, the MPI is 0.4 ($2/$5). In practice, the MPI is much lower, especially in relation to the MPC.
How the Marginal Propensity to Invest (MPI) Impacts the Economy
Consumption tends to be impacted more by increases in income, although the MPI does have an impact on the multiplier effect and also affects the slope of the aggregate expenditures function. The larger the MPI, the larger the multiplier. For a business, increases in income can be the result of reduced taxes, changes in costs, or changes in revenue.
According to Keynesian theory, an increase in investment spending will employ people immediately in the investment goods industry and have a multiplied effect by employing some multiple of additional people elsewhere in the economy. This is an obvious extension of the idea that spending on investment will be re-spent. However, theres a limit to the effect. The real output of the economy is limited to output at full employment, and spending multiplied past this point will simply raise prices—especially in the case of capital goods or financial assets.
Keynesian theory, and its critics, also suggest that any given investment project (public or private) may not always raise income and employment with the full force of the multiplier because that decision to invest may take the place of investment that would have happened in its absence.
For example, funding a project might raise interest rates, discouraging other investments or competing with other projects for labor. This is related to the phenomenon that economists refer to as crowding out, where public investment spending or other policies meant to encourage investment have diminished or even have a negative effect on economic growth to the extent that they replace investment that would otherwise have occurred, rather than encouraging additional investment.