Marginal Propensity to Consume vs. Marginal Propensity to Save: An Overview
Historically, consumer demand and consumption have helped drive the U.S. economy. When American consumers have a greater amount of extra income, they might spend a portion of it, thereby spurring growth in the economy. Consumers might also save a portion of their extra income.
These tendencies aren't mere observations but are the basis for the marginal propensity to save (MPS) and the marginal propensity to consume (MPC).
- The marginal propensity to save (MPS) is the portion of each extra dollar of a household’s income that's saved.
- MPC is the portion of each extra dollar of a household’s income that is consumed or spent.
- Consumer behavior concerning saving or spending has a very significant impact on the economy as a whole.
Marginal Propensity to Save
The marginal propensity to save (MPS) is the portion of each extra dollar of a household’s income that's saved. The MPS indicates what the overall household sector does with extra income—specifically, the percent of extra income that is saved.
As saving is a complement of consumption, the MPS reflects key aspects of a household’s activity and its consumption habits. It is expressed as a percentage. For example, if the marginal propensity to save is 10%, it means that out of each additional dollar earned, 10 cents is saved.
The marginal propensity to save is calculated by dividing the change in savings by the change in income. For example, if consumers saved 20 cents for every $1 increase in income, the MPS would be .20 (.20/$1) or 20%.
The MPS reflects the savings amount or leakage of income from the economy. Leakage is the portion of income that's not put back into the economy through purchases of goods and services. The higher the income for an individual, the higher the MPS as the ability to satisfy needs increases with income. In other words, each additional dollar is less likely to be spent as an individual becomes wealthier. Studying MPS helps economists determine how wage growth might influence savings.
Marginal Propensity to Consume
The marginal propensity to consume (MPC) is the flip side of MPS. MPC helps to quantify the relationship between income and consumption. MPC is the portion of each extra dollar of a household’s income that is consumed or spent. For example, if the marginal propensity to consume is 45%, out of each additional dollar earned, 45 cents is spent.
Economic theory tends to support that as income increases, so too does spending and consumption. MPC measures that relationship to determine how much spending increases for each dollar of additional income. MPC is important because it varies at different income levels and is the lowest for higher-income households.
The marginal propensity to consume is calculated by dividing the change in spending by the change in income. For example, if consumers spent 80 cents for every $1 increase in income, the MPC would be .80 (.80/$1) or 80%.
For example, imagine that Congress wants to enact a tax rebate to spur economic activity through consumer spending. MPC can be used to assess the likelihood of which household's, based on their income, would have the greatest likelihood or propensity to spend the tax cut, rather than save it.
The MPC percentage can also be used by economists to determine how much of each $1 in tax rebates will be spent. In doing so, they can adjust the total size of the rebate program to achieve the desired spending per household.
The MPC is also vital to the study of Keynesian economics, which is the result of economist John Maynard Keynes. Keynesian economics was developed during the 1930s in an attempt to understand the Great Depression. Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression. The extent to which stimulus adds to economic growth is called the Keynesian multiplier.
The MPC, like the MPS, affects the multiplier process and affects the magnitude of expenditures and tax multipliers. Ultimately, both MPS and MPC are used to discuss how a household utilizes its surplus income, whether that income is saved or spent. Consumer behavior concerning saving or spending has a very significant impact on the economy as a whole.