3.8: The Marginal Propensity to Save

The Marginal Propensity to Save (MPS) describes the proportion of additional disposable income that a household saves rather than spends. It is calculated by dividing the change in savings by the change in disposable income. This ratio helps economists understand individual and aggregate saving behavior and is critical in developing models of income distribution and economic growth.

Example of MPS Calculation

To illustrate, imagine that Kevin's disposable income increases by one hundred dollars. If he chooses to save twenty dollars from this additional income, his MPS is 0.2. This means Kevin saves twenty cents for every extra dollar he earns. The MPS always falls between zero and one. An MPS of zero indicates that all additional income is spent, whereas an MPS of one means all of it is saved.

Relationship Between MPS and MPC

The Marginal Propensity to Consume (MPC) complements the MPS. MPC measures the fraction of additional income that is used for consumption. The two values are directly related through a simple identity:

MPC + MPS =1.

This is because any increase in disposable income must be either consumed or saved. Using Kevin's example, if he saves twenty percent of his additional income (an MPS of 0.2), the remaining eighty percent must be spent (an MPC of 0.8).

Broader Economic Significance

Understanding the relationship between MPS and MPC is vital for evaluating how income changes influence overall economic activity. A higher MPC suggests that more of the additional income is spent, which can stimulate demand and promote short-term economic growth. A higher MPS, on the other hand, reflects a greater tendency to save, which may support long-term investment and capital accumulation.

Policymakers use these concepts to predict the effects of fiscal measures such as tax cuts or direct stimulus payments on consumption, savings, and national output. The MPS also plays an important role in calculating the spending multiplier, which determines how initial changes in spending lead to broader shifts in aggregate economic output.

The Marginal Propensity to Save, or MPS, is the fraction of additional disposable income that people choose to save instead of spending.

It’s calculated by dividing the change in savings by the change in disposable income. MPS determines the slope of a linear savings function.

Consider Kevin. If his disposable income increases by $100, and he decides to save $20, his MPS is 0.2. That means Kevin saves 20 cents out of every extra dollar he earns.

MPS ranges from 0 to 1. A value of 1 means all extra income is saved, while zero means none is saved.

Now, here’s a key idea in macroeconomics: the Marginal Propensity to Consume plus the Marginal Propensity to Save always equals one.

When a person receives additional disposable income, they have only two choices for allocating some or all of it.

They can spend a portion of it, as determined by the MPC, or they can save a portion of it, as determined by the MPS.

This relationship helps economists predict how changes in income impact overall spending, saving, and economic growth.