What is Marginal Propensity to Save (MPS)?
Marginal propensity to save (MPS) refers to the proportion of the next dollar received that a consumer would save as opposed to spending.
Economists use marginal propensity to save (MPS) to measure the link between changes in income and changes in savings. It refers to the fraction of a salary increase that a consumer saves rather than spends on goods and services. The marginal propensity to save is commonly thought to be larger for wealthier people than for poorer people.
The marginal propensity to save (MPS) in Keynesian economic theory analyzes increases in aggregate income. MPS is defined as the proportion that a consumer saves rather than spends on goods and services. In other words, it is the percentage of additional income that is saved rather than spent. MPS is calculated as the change in savings divided by the change in income and can be graphically depicted by a savings line. A savings line is a sloped line made by charting the change in savings on the vertical y-axis and the change in income on the horizontal x-axis to represent MPS.
Marginal Propensity to Save (MPS) – A Closer Look
Economists can estimate the MPS of a household by income level using data on household income and household savings. However, this computation is not constant. It varies according to income level and any changes that occur. Typically, the higher the income, the higher the MPS. This is because as income grows, so does the ability to satisfy basic needs and wants. However, as income rises, each additional dollar is less likely to be spent. Nevertheless, the possibility exists that a raise in salary will cause a change to that consumer’s savings and consumption patterns.
For example, a boost in earnings means being able to cover household bills more easily with more room to save. However, higher pay entails greater access to goods and services that require bigger expenditures. This might involve purchasing a higher-end or luxury automobile or relocating to a larger, more expensive property.
Economists can predict how increases in government or investment spending will affect savings vs boost the economy. But first, they need to know what the consumer MPS is. The formula 1/MPS is used to compute the expenditures multiplier. The expenditures multiplier indicates how changes in consumers’ marginal propensity to save affect the rest of the economy. The smaller the MPS, the greater the multiplier and the greater the economic impact of a shift in government expenditure or investment.
Marginal Propensity to Save Formula
The formula below is used in calculating MPS:
Marginal Propensity to Save = Change in savings / Change in income
- The savings rate changes by the value of MPS if the income changes by a dollar. MPS is equivalent to the saving function slope. Graphically illustrated, the horizontal line (x-axis) represents a change in income, while the vertical line (y-axis) represents a change in saving.
- MPS varies between 0 and 1. MPS is equal to one (1) if the entire additional income is saved. Conversely, MPS is equal to zero (0) if the income is entirely spent with nothing added to savings. An MPS of zero (0) indicates that changes in income have no effect on savings.
How to calculate MPS – Example
Suppose you receive a $3o00 bonus with your year-end paycheck. You suddenly have $3000 more in income than you did before. You decide to spend $2000 of this marginal increase to pay off credit card debt and save the remaining $1000. Therefore, your marginal propensity to save is 0.333 ($1000 change in saving divided by $3000 change in income).
How to calculate MPC – Example
The flip side of the marginal propensity to save is the marginal propensity to consume (MPC). MPC shows how much a change in income affects consumption and purchasing levels. In this example, you spent $2000 of your $3000 bonus. Therefore, your marginal propensity to consume is 0.667 ($2000 divided by $3000). Adding MPS (0.333) to MPC (0.667) equals 1.
Factors that Influence the Marginal Propensity to Save (MPS)
- Income levels. At low-income levels, consumers spend most of their income on basic living needs. An increase in income, will probably all be spent. However, as income levels rise, extra income has a diminishing utility. At higher income levels, with all necessities covered, saving becomes possible. The Keynesian consumption function shows that the marginal propensity to consume falls at higher incomes. This means the marginal propensity to save rises.
- Consumer Confidence – Confidence in the future affects the marginal propensity to save. Households spend more when they feel confident. They save more when they fear the future.
- Life-cycle influences – In theory, individuals tend to smooth out their consumption over time. During college years, marginal propensity to save will be low or zero. Often, students probably will borrow. Eventually, they enter the workforce, get a better-paid job, and pay off their debts. At this point, they will be in a position to increase their savings. During their mid-working life, individuals will tend to have the highest propensity to save. During this period, they can even put money aside for retirement.
- Individual preferences. Not all individuals are rational. Some individuals do not follow the life-cycle models and may fail to save. Estimates indicate one-quarter of individuals are more prone to present-income bias. This means individuals place a higher weight on consumption vs saving for the future.
- Risk vs reward – Some individuals are risk-averse. Therefore, they are more likely to save extra income for emergencies like unemployment. Risk-taking individuals may not care, so don’t bother saving.
- Opportunity Cost – Consumers normally save or invest more when they have a high-return investment available. For example, many consumers would deposit more in savings if the interest increased from 2 percent to 10 percent. As a result, a household’s MPS is higher when interest rates are higher.
Up Next: What Is Forward Integration?
Forward integration occurs when a company moves downstream in the value chain toward controlling the distribution of its products or services. It does this by acquiring or merging with businesses downstream that were its former customers. However, it still maintains control over its core business activities.
Forward integration is a business strategy that involves a form of downstream vertical integration. The company maintains control of its core business activities that are ahead in the value chain. However, by integrating downstream through direct distribution, the company can consolidate costs and moves closer to the ultimate end customer.