What is Marginal Propensity to Save (MPS)?
Marginal propensity to save (MPS) is the ratio of any change in savings and income caused by a change in savings and income. MPS is an indicator that indicates the size of the share of each newly earned monetary unit of income that goes to savings instead of consumption. The MPS is equal to the difference in consumption between one and the other group of the population divided by the difference in income of those groups.
How to calculate MPS?
Economists use marginal propensity to save (MPS) to measure the link between income changes and savings changes. It refers to the proportion of a rise in salary that a customer saves rather than utilizes for consuming goods and services.
The formula of MPS
MPS may be computed as the change in savings divided by the change in income. MPS is most commonly employed in Keynesian economic theory. It is determined simply by dividing the change in savings seen given a change in income:
MPS = Change in savings / Change in income
Or technically, the marginal propensity to save (MPS) function is represented as the derivative of the savings (S) function concerning disposable income (Y).
MPS = dS / dY
Function of savings
Like the propensity to spend, the marginal propensity to save is calculated by the ratio of changes in savings to changes in income. Expresses the share of changes in savings per each monetary unit of additional income. In the literature, this concept is called MPS – marginal propensity to save.
MPS = Changes in savings / income
The claim that consumption grows with income growth is very simple evidence. Take, for example, a family with an income of $6,000. It saves 2% of the amount, and all other money goes to various expenses. What can you afford for that money? Pay utility bills, buy a minimal set of products, and probably everything.
The family income begins to grow. Already, the total contribution ratio is $10,000. Now you can buy more meat, go to the cinema once and afford to buy a new dress. But the amount set aside for savings will still remain the same. Because first of all, a person will meet their needs, and only then think about the amount of savings.
Factors influencing savings changes
The growth or reduction of savings does not only depend on wage growth. In the economic environment, many other indicators will somehow change the ability of consumers. The marginal propensity to save also depends on these factors.
- Inflation. Inflation growth is usually much higher than wage indexation. As a rule, prices rise monthly, while family income grows no more than once a year. Therefore, the consumer has to spend a large amount on the purchase while there is no more money to save.
- Tax increase. An increase in deductions leads to a proportional reduction in all costs and propensity to accumulate.
- Price increase. This factor will significantly affect low-income households. Those who receive a high salary will postpone the same.
- Growth in social security payments. This is a very interesting factor. Most often, the propensity to save occurs when a person feels insecure by the state. We need money in case of illness, sudden death, etc. If the insurance fund insures all that, then they need for separate savings will disappear. Therefore, with increasing social contributions, the propensity to save decreases.
- Growth of offers on the market. This is purely a marketing factor. Drug attacks usually occur during periods of sudden outbreaks, pandemics, etc. As consumption increases, savings decrease.
- Revenue growth. As already mentioned, consumption and savings increase with the number of funds.
The propensity to save in macroeconomics
The concept of savings is very important not only for individual households but also for the whole country. The marginal propensity to save shows whether people within the state can ensure the development and growth of production. Does it seem that a simple indicator can?
In fact, the higher the value, the more free money is in the hands of individuals and legal entities, which means they are potential investors. Investments are monetary investments in the sphere of production and, at the same time, a powerful tool for influencing the development of the country. The more money invested in innovation, technological innovation, etc., the higher the economic growth rates.
Deficit or negative savings
Every income, whether family, business or government, is divided into consumption and savings. That is the principle. However, if a family, company, or government spends more than disposable income, then consumption is greater than income, and we have negative savings that we call deficit or loss.
Although research does not confirm this, Keynesians believe that an increase in income increases the share of MPS concerning consumption. The risk, based on the uncertainty, to which each entity is exposed requires its coverage. As the risk is not always related to the amount of income, this follows the rule: the lower the income, the greater the reserve is needed to cover it. E.g. the disease requires certain costs regardless of whether it is a disease of a rich or a poor person.
Formally speaking, the income ratio can be:
Y = C + S where:
Y – income of the respective sector
C – consumption of the respective sector
S – savings of the respective sector
if there is no saving, then S = 0, so our expression reads:
Y = C
that is, if there are negative savings, we have:
Y – S = C
If we replace negative savings and define it as a loan (L), then our relationship is:
Y + L = C.
What else affects the level of MPS?
Certain factors are not significant to income and have a considerable impact on a person’s ability to save money.
The first factor is waiting. If there is a crisis situation in the country and a person is waiting for prices to rise soon, and service fees will increase, then they will pledge as much as possible now, at lower prices. Fear of empty shelves and huge expenses make people spend all their money here and now. But otherwise, when the future is expected to lower prices, or at least their constant level, a person will procrastinate rather than spend.
Another factor is consumer debt. We live in a world of credit. And now there is such a tendency that all the population’s savings are simply converted into payment as a ratio for a product or service in future periods. The level of the average salary is not enough to delay anything for a large purchase. You can save ten years for a car, or you can take it on credit and then pay ten years. So, our desire and ability to accumulate something turns into a powerful tool of the economy – credit.
Paradox of thrift
An increase in consumption or a decrease in savings represents an increase in demand for a particular commodity. Increased demand increases sales. The increase in sales can reach a level that the existing production capacities cannot reach. Then there is a rise in prices, and a rise in prices increases the company’s revenue. Increased revenues will encourage companies to expand their capacities, i.e. to new investments. If we look at the economy as a whole, an increase in national income leads to an increase in investment.
The marginal economy points out that paradox thrift has always been excellent and desirable. Keynes rejected such a claim. He believes that a distinction should be made between the state of full employment and the maximum level of national income, on the one hand, and the state of unemployment and reduced level of national income, on the other hand. According to Keynian’s understandings, the marginalist doctrine of thrift is sustainable only if the economy is at the level of full employment, ie. If all factors of production are maximized and if the maximum level of national income is reached. The essence of the paradox is that increased savings lead to that
- the decline in national income
- investment decline
The relationship between consumption and savings
We assume that the following factors determine the level of national income:
- consumption ratio structure of individual population groups,
- preference for consumption of the total population of one country,
- interaction of savings and investments.
Each income is divided into two parts:
- on the part intended for consumption
- part intended
Consumption and savings are two purposeful parts of income and represent two complementary quantities. Increasing one leads to decreasing the other and vice versa. The MPS and the propensity to consume show the relative ratio of consumption or savings to income, i.e. they show how much of the income goes to consumption or savings.
Example – Marginal Propensity to Save (MPS)
For example, imagine an engineer with a $100,000 shift in income from the prior year due to a pay rise and bonus. The engineer determines that they want to spend $50,000 of the increase in income on a new automobile and save the other $50,000. The resultant marginal propensity to save is 0.5, which is determined by dividing the $50,000 change in savings by the $100,000 change in income.
Therefore, for each extra $1 of income, the engineer’s savings account rises by 50 cents.
In economics, the marginal propensity to consume (MPC) is defined as the proportion of an aggregate raise in pay that a consumer spends on goods and services.
No, neither MPS nor MPC can ever be negative since MPC is the ratio of change in the consumption expenditure and change in the disposable income.
MPS is most commonly employed in Keynesian economic theory. It is determined by dividing the change in savings seen given a change in income: MPS = ΔS/ΔY.
Be sure to check out our MPC – Marginal Propensity to Consume Calculator if you want to find out what is marginal propensity to consume and how to calculate it. Also, if you are curious, you can read about how does it affects government spending and macroeconomics balance. You can find some information about John Maynard Keynes, founder of MPS AND MPC. For more calculators in math, physics, finance, health, and more, visit our CalCon Calculator official page.