Marginal_propensity_to_save

What Is Marginal Propensity to Save?

The marginal propensity to save (MPS) is an economic concept that measures the proportion of an increase in disposable income that a household or economy chooses to save rather than spend. It is a fundamental component of macroeconomics, offering insight into how changes in income influence consumer savings behavior. The marginal propensity to save indicates how much of each additional dollar of income is set aside, highlighting the propensity of individuals to defer current consumption for future use.

History and Origin

The concept of marginal propensity to save stems directly from the work of economist John Maynard Keynes, particularly his theories introduced in The General Theory of Employment, Interest and Money published in 1936. Keynes’s work laid the foundation for modern macroeconomics and introduced the idea of the consumption function, which posits that consumption is primarily determined by current income. As a corollary, any portion of income not consumed is saved. Therefore, the marginal propensity to save, alongside the marginal propensity to consume (MPC), became a critical tool for understanding how changes in national income influence aggregate economic activity. This framework allowed economists and policymakers to better analyze and predict the impact of various fiscal policy and monetary policy measures on an economy.

Key Takeaways

• The marginal propensity to save (MPS) quantifies the fraction of an additional unit of income that is saved.
• MPS is a crucial concept in Keynesian economics, complementing the marginal propensity to consume (MPC).
• It influences the multiplier effect, which describes how initial changes in spending or saving can lead to larger changes in economic output.
• A higher MPS generally indicates a greater tendency for individuals to save new income, potentially affecting aggregate demand and economic growth.

Formula and Calculation

The marginal propensity to save is calculated as the change in savings divided by the change in disposable income.

The formula for the marginal propensity to save (MPS) is:

Where:

• ΔS represents the change in savings.
• ΔYd represents the change in disposable income.

Since every additional unit of disposable income is either consumed or saved, the sum of the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) must always equal 1:

This relationship highlights the inverse nature of consumption and saving decisions concerning new income.

Interpreting the Marginal Propensity to Save

Interpreting the marginal propensity to save involves understanding its implications for individual financial behavior and broader economic trends. An MPS value ranges between 0 and 1. An MPS of 0.30, for example, means that for every additional dollar of household income, 30 cents will be saved. The remaining 70 cents would be spent, reflecting a marginal propensity to consume (MPC) of 0.70.

A higher MPS suggests that individuals are inclined to save a larger portion of any new income, potentially leading to a slower increase in consumer spending and, consequently, a more muted impact on overall Gross Domestic Product (GDP). Conversely, a lower MPS indicates that a greater share of new income is spent, which can stimulate economic activity more rapidly. Various factors, such as economic uncertainty, interest rates, and cultural attitudes toward saving, can influence an economy's typical marginal propensity to save.

Hypothetical Example

Consider a hypothetical scenario for a household. John receives a bonus of $1,000 from his job. Before the bonus, John's monthly disposable income was $4,000, and he saved $400. After receiving the $1,000 bonus, his new disposable income becomes $5,000. He decides to increase his monthly savings to $650.

To calculate John's marginal propensity to save:

1. Calculate the change in savings (ΔS):
   New savings = $650
   Old savings = $400
   ΔS = $650 - $400 = $250

2. Calculate the change in disposable income (ΔYd):
   New disposable income = $5,000
   Old disposable income = $4,000
   ΔYd = $5,000 - $4,000 = $1,000

3. Apply the MPS formula:
   MPS = ΔS / ΔYd = $250 / $1,000 = 0.25

In this example, John's marginal propensity to save is 0.25, meaning he saves 25 cents of every additional dollar of income. This also implies his marginal propensity to consume (MPC) is 0.75, as he spends 75 cents of every additional dollar of disposable income.

Practical Applications

The marginal propensity to save has several practical applications in economic analysis and policymaking. Governments and central banks use it to forecast the impact of policy changes. For instance, understanding the MPS is crucial when implementing fiscal stimulus measures, such as tax cuts or direct payments, as a higher MPS might mean a significant portion of the new funds are saved rather than immediately spent, potentially dampening the intended stimulative effect on aggregate demand.

Economists also track national personal saving rates, which are influenced by the collective marginal propensity to save of households. For example, the U.S. Bureau of Economic Analysis (BEA) and the Federal Reserve Bank of St. Louis (FRED) provide data on the personal saving rate, which reflects personal saving as a percentage of disposable personal income. This data ¹², ¹³, ¹⁴helps gauge the financial health of households and predict future consumer behavior. Globally, household saving rates vary significantly due to institutional, demographic, and socioeconomic differences. For instan¹⁰, ¹¹ce, countries like Switzerland, Germany, and France have historically shown higher household saving rates compared to others.

Limita⁸, ⁹tions and Criticisms

While the marginal propensity to save (MPS) is a foundational concept in macroeconomics, it faces certain limitations and criticisms, particularly when applied universally or over long periods. One primary critique stems from the original Keynesian consumption function, which assumes a stable, linear relationship between current income and consumption/saving. However, r⁶, ⁷eal-world behavior is often more complex. Factors like wealth, expectations about future income, interest rates, and credit availability can significantly influence saving decisions beyond just current income levels.

Critics a⁴, ⁵lso point out that the MPS, as part of the Keynesian framework, may not fully account for long-term economic dynamics or the supply side of the economy. Some argue², ³ that an excessive focus on stimulating demand through lower MPS (i.e., higher MPC) can lead to issues like inflation or unsustainable levels of government debt. Furthermore, the concept of the paradox of thrift highlights a potential counterintuitive outcome where an increase in society's overall desire to save (higher MPS) during an economic downturn can actually reduce aggregate demand and worsen the recession, as reduced spending leads to lower income for others.

Margin¹al Propensity to Save vs. Marginal Propensity to Consume

The marginal propensity to save (MPS) is inherently linked to the marginal propensity to consume (MPC). These two concepts describe how additional income is allocated between spending and saving. The key difference is their focus: MPC measures the proportion of additional disposable income that is spent on goods and services, while MPS measures the proportion that is saved.

The relationship between them is straightforward: MPC + MPS = 1. This means that if an individual's MPC is 0.80 (they spend 80 cents of every new dollar), their MPS must be 0.20 (they save 20 cents of every new dollar). Confusion can arise if one considers only consumption or savings in isolation, but it's essential to remember that these two propensities together account for the entire change in disposable income. Both are critical for understanding the mechanics of the multiplier effect, where an initial change in spending or saving can lead to a magnified impact on overall economic output.

FAQs

What is a good marginal propensity to save?

There isn't a universally "good" marginal propensity to save, as it depends on economic conditions and individual financial goals. For an individual, a higher MPS means building savings more quickly, which can be beneficial for financial security. For an economy, a very high MPS might temper immediate economic growth by reducing consumer spending, while a very low MPS might indicate less financial resilience in households.

How does marginal propensity to save affect the economy?

The marginal propensity to save affects the economy primarily through its influence on the multiplier effect. A higher MPS reduces the portion of new income that is immediately spent, leading to a smaller multiplier effect and thus a less significant expansion in overall Gross Domestic Product (GDP) for a given initial injection of spending. Conversely, a lower MPS (meaning a higher marginal propensity to consume) results in a larger multiplier effect, as more of the new income is recirculated through spending.

Is marginal propensity to save always positive?

In theory, the marginal propensity to save is generally considered positive, meaning that as disposable income increases, so do savings, albeit not necessarily at the same rate. This is based on Keynes's psychological law of consumption. However, in specific situations, such as during severe economic contractions or when households are heavily indebted, a marginal propensity to save could theoretically approach zero or even become negative if individuals are forced to reduce savings or borrow to maintain consumption levels.

How is marginal propensity to save different from average propensity to save?

The marginal propensity to save (MPS) measures the change in savings due to a change in disposable income. In contrast, the average propensity to save (APS) measures the total proportion of disposable income that is saved. APS is calculated by dividing total savings by total disposable income. While MPS focuses on the incremental decision of how to allocate new income, APS reflects the overall saving behavior relative to total income.