Marginal Propensity to Save (MPS)
The Marginal Propensity to Save (MPS) is a core concept in macroeconomics that quantifies the fraction of any additional dollar of disposable income that an individual or household chooses to save rather than spend. It is a fundamental component for understanding how changes in income translate into changes in saving behavior within an economy. The Marginal Propensity to Save is a critical metric for economists and policymakers, as it provides insight into consumption patterns and their implications for economic growth and stability.
History and Origin
The concept of marginal propensity to save, alongside its counterpart, the marginal propensity to consume, emerged prominently with the advent of Keynesian economics. British economist John Maynard Keynes introduced these ideas in his seminal 1936 work, The General Theory of Employment, Interest, and Money. Keynes posited that as income increases, individuals and societies tend to spend a portion of that additional income on consumption and save the remainder. This behavioral principle laid the groundwork for understanding the relationship between income, consumption, and saving, and became a cornerstone of modern national income determination. Keynes's work profoundly influenced economic thought and policy during the Great Depression and continues to shape discussions about aggregate demand and government intervention.5
Key Takeaways
- The Marginal Propensity to Save (MPS) represents the proportion of an increase in disposable income that is allocated to saving.
- MPS is always between zero and one, meaning that for every additional dollar of income, some portion will be saved, and some will be consumed.
- It is inversely related to the marginal propensity to consume (MPC); their sum always equals one (MPS + MPC = 1).
- Understanding MPS is crucial for predicting consumer behavior and the potential impact of economic stimuli or policies.
- MPS plays a vital role in determining the magnitude of the multiplier effect in an economy.
Formula and Calculation
The Marginal Propensity to Save (MPS) is calculated as the change in savings divided by the change in disposable income.
Mathematically, the formula is expressed as:
Where:
- ( \Delta S ) represents the change in household savings.
- ( \Delta Y_d ) represents the change in disposable income.
For instance, if a household's disposable income increases by $100 and their savings increase by $20, their MPS would be 0.20 or 20%.
Interpreting the MPS
Interpreting the Marginal Propensity to Save involves understanding what a specific MPS value implies about an economy's or individual's saving behavior. An MPS value close to 1 suggests that most of any additional income is saved, indicating a high propensity to save. Conversely, an MPS value close to 0 indicates that most of any additional income is consumed, implying a low propensity to save.
A higher Marginal Propensity to Save generally means that a smaller portion of new income re-enters the spending stream, potentially leading to a smaller multiplier effect from initial changes in spending or investment. For example, in an economy with a high MPS, government stimulus might have a less pronounced impact on overall gross domestic product because a larger share of the new income is set aside rather than spent on goods and services.4
Conversely, a lower MPS suggests that a larger portion of new income is spent, leading to a greater economic equilibrium and a more significant boost to overall economic activity through the multiplier. The average MPS for an economy can be estimated by looking at the national personal saving rate.3
Hypothetical Example
Consider a hypothetical economy, "Econoville," where the government implements a tax cut that increases the disposable income of its citizens.
Scenario:
- Initial disposable income for a representative household: $3,000
- Initial monthly savings for the household: $300
- After the tax cut, disposable income increases to: $3,500
- After the tax cut, monthly savings increase to: $400
Calculation of MPS:
-
Calculate the change in disposable income (( \Delta Y_d )):
( \Delta Y_d = \text{New Disposable Income} - \text{Initial Disposable Income} = $3,500 - $3,000 = $500 ) -
Calculate the change in savings (( \Delta S )):
( \Delta S = \text{New Savings} - \text{Initial Savings} = $400 - $300 = $100 ) -
Calculate the MPS:
( MPS = \frac{\Delta S}{\Delta Y_d} = \frac{$100}{$500} = 0.20 )
In this example, the Marginal Propensity to Save for the household in Econoville is 0.20, or 20%. This means that for every additional dollar of disposable income received, the household saves 20 cents and consumes the remaining 80 cents (which implies a marginal propensity to consume of 0.80).
Practical Applications
The Marginal Propensity to Save (MPS) has several practical applications in economic analysis and policymaking:
- Fiscal Policy Formulation: Governments use MPS to estimate the potential impact of fiscal policy measures, such as tax cuts or government spending increases. A lower MPS implies that a larger portion of fiscal stimulus will be spent, leading to a more potent multiplier effect and greater economic expansion. Policymakers consider MPS when designing stimulus packages aimed at boosting aggregate demand during economic downturns.2
- Economic Forecasting: Economists use historical MPS data and current trends to forecast future consumption function patterns and overall economic activity. Understanding how changes in income influence saving versus spending helps predict consumer behavior, which is a significant driver of gross domestic product.
- Monetary Policy Considerations: While MPS is directly related to fiscal policy, it indirectly influences the effectiveness of monetary policy. For example, if low interest rates are intended to stimulate spending, a high MPS might limit the extent to which consumers respond by increasing consumption rather than saving.
- Business Strategy: Businesses and investors analyze MPS trends to gauge consumer confidence and spending potential. A rising MPS might signal that consumers are becoming more cautious, potentially leading to weaker retail sales, while a falling MPS could indicate increased consumer willingness to spend.
Limitations and Criticisms
While the Marginal Propensity to Save (MPS) is a foundational concept in macroeconomics, it faces several limitations and criticisms:
- Simplification of Behavior: The MPS, especially in its simple Keynesian form, assumes a relatively stable and predictable relationship between income and saving. In reality, consumer behavior is influenced by many factors beyond current disposable income, such as accumulated wealth effect, expectations about future income, consumer confidence, availability of credit, and social norms.
- Short-Run vs. Long-Run: The MPS tends to be more stable in the short run. Over the long run, factors like technological advancements, changes in demographics, or shifts in cultural attitudes towards saving can alter the marginal propensity to save, making simple predictions less reliable.
- Aggregate vs. Individual: The aggregate MPS for an entire economy may not accurately reflect the behavior of individual households. Different income groups often have varying MPS values; lower-income households tend to have a lower MPS (saving less of additional income), while higher-income households typically have a higher MPS.
- Empirical Challenges: Accurately measuring the MPS in real-world economies is challenging. Data collection methods for saving and disposable income can vary, and other concurrent economic events can obscure the direct relationship being measured. Economists like Milton Friedman questioned the stability of the traditional consumption function (and by extension, MPS) based on empirical inconsistencies, proposing alternative theories like the permanent income hypothesis, which consider a broader view of income over a lifetime.1 This suggests that individuals smooth consumption over time, making their saving decisions more complex than a simple response to current income changes.
Marginal Propensity to Save (MPS) vs. Marginal Propensity to Consume (MPC)
The Marginal Propensity to Save (MPS) and the marginal propensity to consume (MPC) are two sides of the same coin, describing how a change in disposable income is allocated. While MPS measures the portion of additional income saved, MPC measures the portion of additional income spent on consumption.
Their relationship is fundamental: the sum of MPC and MPS must always equal 1. This is because every additional dollar of disposable income can either be consumed or saved. Therefore, if MPC is known, MPS can be easily derived (MPS = 1 - MPC), and vice-versa. For example, if the MPC for an economy is 0.75, it implies that for every extra dollar of income, 75 cents will be spent, and thus, 25 cents will be saved (MPS = 0.25). Both concepts are crucial for understanding the overall economic equilibrium and the impact of economic policies.
FAQs
What is a good Marginal Propensity to Save (MPS)?
There isn't a universally "good" MPS, as the optimal level depends on an economy's stage of development, policy goals, and cultural factors. For individuals, a "good" MPS depends on personal financial goals, such as saving for retirement or a down payment. From a macroeconomic perspective, a balanced MPS, allowing for both sufficient consumption to drive aggregate demand and sufficient saving for investment, is generally desirable.
Can MPS be greater than 1 or less than 0?
In theory, the Marginal Propensity to Save (MPS) is always between 0 and 1. An MPS greater than 1 would imply that an individual saves more than the additional income received, which is not economically possible. An MPS less than 0 (negative) would mean that an increase in income leads to a decrease in savings, or even dissaving, which can happen in very specific short-term scenarios (e.g., if a person suddenly faces a large unexpected expense immediately after an income boost), but it is not the general behavioral assumption in the context of the aggregate economy.
How does MPS affect the multiplier effect?
The Marginal Propensity to Save (MPS) has an inverse relationship with the multiplier effect. The multiplier formula is ( \frac{1}{MPS} ) (or ( \frac{1}{1 - MPC} )). This means that a higher MPS leads to a smaller multiplier, as a larger portion of any additional income is withdrawn from the spending stream through saving. Conversely, a lower MPS results in a larger multiplier, as more of the new income is spent, creating further rounds of economic activity. Understanding this relationship is vital for predicting the impact of fiscal policy on national income.
Is a high MPS good or bad for the economy?
Whether a high Marginal Propensity to Save is "good" or "bad" for an economy depends on the economic context. In the short run, a very high MPS can lead to a reduction in aggregate demand, potentially slowing economic growth if there isn't enough investment to offset the increased saving. This can be problematic during a recession. However, in the long run, a higher MPS contributes to higher levels of household savings, which can provide a larger pool of funds for investment, capital formation, and sustainable long-term economic expansion.