The marginal propensity to import (MPM) is the proportion of change in the volume of imports due to a change in income. This concept holds that the proportion of foreign leakage will naturally increase with rising income. Foreign leakage refers to the money that leaves the domestic economy from a circular flow of income.
Rising income for households and businesses increases consumption expenditure and part of it is used to buy goods from abroad. MPM, therefore, shows the correlation between a change in imports and a change in the amount of income. If the MPM is 0.3, it means that an extra dollar of income induces 30 cents of imports for every dollar.
The marginal propensity to import (MPM) refers to the change in the volume of imports due to a change in income.
It plays a key role in Keynesian microeconomic theory by showing the extent to which imports change with changes in income or production.
Developed economies with sufficient natural resources have low marginal propensities to import compared to developing countries that rely on imported goods and have a higher marginal propensity to import.
Understanding Marginal Propensity to Import
In Keynesian macroeconomic theory, MPM is a useful concept that is used to indicate the extent to which changes in income or production induce changes in imports. When comparing imports and income, it is expected that a household’s demand for overseas goods depends on their demand, as does their demand for local goods. Subsequently, a firm’s demand for goods from abroad, such as raw materials and other components, depends on its output.
Countries that import more goods with an increase in the population’s incomes are key in the global trade. When such a country runs into a financial crisis, the degree of the impact on exporting countries depends on its MPM. A country with a higher MPM than the average propensity to import is likely to see a greater impact than exporting countries.
How to Calculate the Marginal Propensity to Import
The formula for calculating the marginal propensity to import is as follows:
There are several interpretations from the formula based on Keynesian economics.
First, the formula shows the degree to which an extra dollar induces the value of imports and exports. If the value of domestic incomes changes by an extra dollar, the value of imports also changes by an equivalent value. Therefore, income triggers a change in the value of imports at a rate determined by the MPM. Since the value of imports reduces the value of net exports, the value of net exports equals the negative of the MPM.
The second interpretation of the formula is that MPM measures the slope of the imports line that compares imports and disposable income on a graph. The slope is labeled as the rise over the run, where the rise denotes the change in imports while the run shows the changes in income. Since the value of imports reduces the value of net exports, the net exports equal the negative of the MPM.
In mathematically formalized models, the marginal propensity to import is expressed as the derivative of import with respect to income, given as:
It is the derivative of the imports function (ɗ’M) divided by the derivative of the income function (ɗ’Y). The value of MPM is not constant as it is impacted by changes in relative prices of both foreign and domestic goods, meaning it could change in the long run for various reasons such as fluctuation in the exchange rate.
If a country’s national income increases by $200, and imports increase by $20, the marginal propensity to import will be $20/$200 = 1/10. The MPM for developed economies with sufficient natural resources tends to be smaller than that of underdeveloped countries with scarce natural resources, which show a higher MPM. The reason behind the relationship is that underdeveloped economies depend on foreign goods to sustain their population.
Strengths and Weaknesses of the Marginal Propensity to Import (MPM)
Marginal propensity to import serves as a useful tool in measuring forecasted changes in imported goods, and it is a preferred tool because it is more accurate and easy to calculate. The accuracy stems from the forecasting error distribution as seen in classical standard deviation.
However, MPI comes with the limitation of giving poor results in some countries, because it gives a dispersion of errors around its average to indicate a consistently stable MPM. It is an unlikely situation due to systematic errors, such as prices of imported goods and locally-produced goods, as well as fluctuations in foreign exchange. The systematic errors affect the purchasing power for imported goods, and subsequently, the country’s MPM.