Historically, people in the United States have shown a higher propensity to consume than a propensity to save. As a result, consumer demand and consumption drive the U.S. economy. When American consumers have a greater amount of extra income, they can most likely be expected to spend the majority of it, thereby spurring the economy.
These tendencies aren't just observations: They can be measured by the marginal propensity to save (MPS) and the marginal propensity to consume (MPC). Both metrics play a starring role in Keynesian economics, quantifying the saving-income relation, which is the flip side of the coin to the consumption-income relation.
Marginal Propensity to Save
The marginal propensity to save (MPS) is the portion of each extra dollar of a household’s income used for saving. It can be calculated by dividing changes in saving by changes in income. 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 45%, it means that out of each additional dollar earned, 45 cents is saved.
Such activity is central to the study of macroeconomics. It is also vital to the study of Keynesian economic theory. The MPS captures induced saving, which is one aspect of the psychological law of spending performed by consumers. The MPS reflects the saving line's slope, which is the foundation on which the Keynesian injections-leakages model is based. The MPS acts as a multiplier, affecting the magnitude of both expenditures and the tax multipliers.
Marginal Propensity to Consume
The marginal propensity to consume (MPC) is the flip side of MPS. Quantifying the consumption-income relation, it indicates the portion of each extra dollar of a household’s income that is consumed or spent, as opposed to saved. This is calculated by dividing changes in consumption by changes in income.
The MPC is also vital to the study of Keynesian economics. It captures induced consumption and the psychological law of consumer spending. The MPC reflects the consumption line's slope, making it the foundation for the slope of the aggregate expenditures line. The MPC, like the MPS, affects the multiplier process and affects the magnitude of expenditures and tax multipliers. For example, if the marginal propensity to consume is 45%, out of each additional dollar earned, 45 cents is spent.
Ultimately, both MPS and MPC are used to discuss the ways in which any entity utilizes its surplus income, whether that income is saved or spent. Consumer behavior in regard to saving or spending has a very significant impact on the economy as a whole.