Marginal Propensity to Consume and Save – Definition & Relation
The Marginal Propensity to Consume (MPC) is a metric that evaluates how sensitive consumption is to unitize changes in income in a given economy. MPC is similar to Price Elasticity in that it can provide new insights by examining the amount of change in consumption as a function of income variations. To put it another way, how much would the average consumer spend if they received an additional of his/her regular income level? The activity or possibility of spending is referred to as ‘propensity,’ which refers to a person’s desire or tendency to do something. As a result, when we talk about the marginal propensity to consume, we’re talking about a person’s proclivity to spend the extra money they get.
The marginal propensity to consume, which relates to the percentage of income spent, will fall between 0 and 1. The customer can spend none of it or all of it, but most of the time it falls somewhere in the middle. The Keynesian multiplier, which defines the effect of additional investment or government expenditure as an economic boost, is determined by MPC.
Many economists believe that the marginal propensity to consume is the more important notion. The marginal propensity to consume affects the overall effect on national income of initial increases in investment or government expenditure via the multiplier process. There are several elements that go into calculating marginal propensity to consume.
When calculating MPC, there are a few things to consider:
1. Rates of Interest
Higher interest rates encourage consumers to save since they will earn more money by putting money away. If a consumer’s bank account pays him no return on his savings, he will be less likely to retain his money there.
2. Consumer Perceptions
People buy when they feel secure. They are more inclined to spend if they know they will receive their income tomorrow. However, if they are concerned about losing their job or experiencing a recession, they will conserve their money and avoid making needless purchases.
3. Levels of Income
If a consumer has a low-income level, any additional money will have a high marginal propensity to consume (statistically). The reason for this is because those with lower salaries have more products and services that they want and desire to purchase, so when they have more money, they will go out and get what they require. Those with greater earnings, on the other hand, are more likely to save since they already have all of the products and services they require.
4. The marginal propensity to consume is the inverse of the marginal propensity to save.
MPC aids in the quantification of the income-to-consumption connection. According to economic theory, as one’s income rises, so do one’s spending and consumption. MPC calculates this connection to see how much spending rises for every dollar of extra income. The marginal propensity to save (MPS) is an economic metric that measures how savings fluctuate when income changes. It’s determined by dividing the difference in savings by the difference in income. Small increases in income lead to big changes in savings, as shown by a higher MPS.
Mathematical Interpretation of MPC:
The MPC function is defined as the instantaneous slope of the C-Y curve, which is the derivative of the consumption function C with respect to disposable income Y.
MPC = dC/dY
By dividing the change in consumption by the change in income, the marginal propensity to consume is calculated.MPC = Change in consumption/Change in income
Consider the case, in this example, a person's income has increased and with that, his consumption has also increased, let us calculate the MPC in this case.
Now, MPC = Change in consumption/Change in income MPC = 150-90/200-100 MPC = 60/100 MPC = 0.6
Definition of Marginal Propensity to Save (MPS):
Consumer demand and spending have historically fueled the economy of every nation. When consumers have more disposable income, they are more likely to spend some of it, resulting in economic development. Consumers may also decide to set aside a part of their surplus cash. These patterns are the foundation for the Marginal Propensity to Save (MPS) and the marginal propensity to consume (MPC).
The MPS measures the amount of money saved or lost in the economy. The amount of revenue that is not reinvested in the economy through purchases of goods and services is referred to as leakage. As an individual's income rises, so do their capacity to meet their demands, resulting in a greater MPS. In other words, as a person's wealth grows, each extra penny is less likely to be spent.
The Marginal Propensity to Save (MPS) is Influenced by a Number of Factors:
1. Levels of income:
Consumers with modest incomes will purchase all of life's needs. An increase in income will very certainly be spent entirely. Saving becomes an affordable extra at higher income levels when all essentials have been purchased.
2. Income's diminishing marginal utility:
The extra income has less usefulness as income levels grow, thus customers may not know what to do with it and so spend a greater amount of it. The Keynesian consumption function illustrates that as income rises, the marginal inclination to consume decreases, while the marginal propensity to save increases.
3. Personal preferences:
Individuals are not all sensible. Around 25% of people do not follow the life-cycle hypothesis models and may not save even if rational utility maximization suggests they should. Some people are more prone to discrimination based on current wealth than others. This indicates that people place a larger value on immediate spending than on saving for the future.
4. Risk-averse – Risk loving:
MPS is largely determined by individual preferences; each individual wishes to spend or save money in his or her own way. Young people tend to believe in spending more, while older people tend to believe in saving more. In the same way, there are two more categories which are risk-averse and risk-lovers. Some people are risk-averse, and as a result, they are more likely to have extra cash on hand – in case of an emergency. Those who like taking chances may not want to save, as a result, the MPS decreases.
Consumer behavior in terms of saving and spending has a huge influence on the economy as a whole. MPS and MPC are used to describe how an individual or an organization (Govt.) spends their surplus funds, whether it is saved or spent. An individual's or organization's (Govt.) income is either spent or saved, thus the total of MPC and MPS must equal 1. That is, when an individual spends more, he or she saves less. This also applies in the opposite direction: saving more implies spending less. As a result, as one rises, the other falls, and vice versa.