Marginal propensity to save (MPS) is used by economists in order to quantify the relationship between changes in income and changes in savings. It refers to the proportion of a raise in pay that a consumer saves rather than uses for consuming goods and services.
- Marginal propensity to save (MPS) is an economic measure of how savings change, given a change in income.
- It is calculated by simply dividing the change in savings by the change in income.
- A larger MPS indicates that small changes in income lead to large changes in savings, and vice-versa.
What Is the Marginal Propensity to Save?
The marginal propensity to save 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 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 or 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.
How Marginal Propensity to Save Is Calculated
MPS is most often used in Keynesian economic theory. It is calculated simply by dividing the change in savings observed given a change in income:
- MPS = ΔS/ΔY
- ΔS is a change in savings, and ΔY is a change in income.
If income changes by a dollar, then saving changes by the value of the marginal propensity to save. The marginal propensity to save is actually a measure of the slope of the savings line, which is created by plotting the change in income on the horizontal x-axis and change in savings on the vertical y-axis. The slope of the savings line is depicted by the change in saving and the change in income, or a change in the y-axis, divided by the change in the x-axis.
So, if consumers saved 20 cents for every $1 increase in income, the MPC would be 0.20 (0.20 / $1). The value of the marginal propensity to save always varies between zero and one, where zero indicates that changes in income have no effect on savings whatsoever.
For example, assume an engineer has a $100,000 change in income from the previous year due to a pay raise and bonus. The engineer decides that they want to spend $50,000 of the increase in income on a new car and save the remaining $50,000. The resulting marginal propensity to save is 0.5, which is calculated by dividing the $50,000 change in savings by the $100,000 change in income.
Therefore, for each additional $1 of income, the engineer's savings account increases by 50 cents.