Final answer:
The Marginal Propensity to Consume (MPC) measures how much consumption changes with an increase in income, while the Marginal Propensity to Import (MPI) measures the change in imports with an increase in income. They are related in that portion of the MPC directed towards imported goods determines the MPI, impacting the level of aggregate expenditures in the domestic economy.
Step-by-step explanation:
Marginal Propensity to Consume and Marginal Propensity to Import
The marginal propensity to consume (MPC) is a measure of how much consumption increases when income increases by one unit. In essence, it represents the proportion of additional income that is used for consumption. For example, if the MPC is 0.8, this means that for every extra dollar earned, 80 cents is spent on consumption. The MPC can be influenced by various factors, including tax rates, as the formula to compute consumption changes when taxes are accounted for. The higher the taxes, the lower the disposable income, thus reducing the MPC.
The marginal propensity to import (MPI) is the proportion of additional income that is spent on imports. This is closely related to the MPC because the portion of consumption that is directed towards imported goods affects the overall level of imports. For example, if the MPI is 0.1, it means that for every dollar increase in income, 10 cents is spent on imports. The MPI can alter the slope of the import function in a Keynesian cross diagram and affects the level of aggregate expenditures in the domestic economy.
Understanding the relationship between the MPC and MPI is crucial for analyzing the open economy, as they both play significant roles in determining the balance of trade and the effect of income changes on domestic and foreign goods consumption.