Why does MPS and MPC equal 1?

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Understanding Marginal Propensity to Save

Marginal propensity to save reflects important aspects of a household’s expenditure habits since saving and consumption go hand in hand. It also paints a picture of the saving amount from a country’s economy.

Also called leakage, a saving amount is the fraction of income that is not injected back into the economy through consumption. The amount is expressed as a percentage, and a higher proportion indicates that an individual receives a higher income and hence demonstrates a greater ability to satisfy their needs.

Usually, a higher income translates to a higher MPS. As people become wealthier, it becomes easier to satisfy their needs, and the additional income earned is more likely to go into savings rather than meet household expenditures.

Still, a higher income may change the consumption habits of an individual and may develop an increased desire for luxury goods and services, such as high-end vehicles, better neighborhoods, and lavish holidays.

Marginal Propensity to Save in Multiplier Effect

Marginal propensity to save also plays a key role in determining the multiplier effect. A multiplier measures a change in the market value of all products produced within a country’s borders, such as the Gross Domestic Product (GDP). It results from a change in the autonomous variable, such as government expenditure.

A change in the production process creates a multiplier effect because it creates an additional disposable income that is spent on consumption. The new consumption creates an income for another sector in the economy, which triggers more consumption and a further change in the production process.

The cycle continues leading to a magnified and multiplied change in maximum output. The spending multiplier is expressed as the inverse of MPS.

The spending multiplier shows how adjustments in consumers’ MPS affect the rest of the economy. The opposite of MPS is the marginal propensity to consume (MPC), which refers to the additional consumer spending triggered by an increase in disposable income.

Calculating Marginal Propensity to Save

The formula below is used in calculating MPS:

The saving changes by the value of MPS if the income changes by a dollar. MPS is equivalent to the saving function slope. In the curve, the horizontal line (x-axis) represents a change in income, while the vertical line (y-axis) represents a change in saving.

Points to note about MPS:

• MPS varies between 0 and 1
• MPS = 1 if the entire additional income is saved
• MPS = 0 if the entire additional income is spent, indicating that changes in income have no effects on savings

Example

Suppose that John receives a $300 bonus with his paycheck. It means that John has $300 in additional income. If he spends $100 of this marginal increase in purchasing a new pair of shoes and saves the remaining $200, his marginal propensity to save is (using the formula above):

This value is important because MPS is not constant. Seasonal trends usually emerge monthly as margins change to heavy spending during holidays, with less active consumer spending months registering high saving levels. Economists use MPS in measuring the correlation between such trends to give the general economic picture of the population.

The marginal propensity to consume differs from MPS. In the above equation, MPC is calculated as follows:

It means that for every dollar earned, 33 cents is spent on consumption while 67 cents is spent on savings. Adding MPC (0.33) to MPS (0.67) equals to 1.

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In Keynesian economic theory, the marginal propensity to save (MPS) refers to the proportion of an aggregate raise in income that a consumer saves rather than spends on the consumption of goods and services. Put differently, MPS is the proportion of each added dollar of income that is saved rather than spent. MPS is a component of Keynesian macroeconomic theory and is calculated as the change in savings divided by the change in income.

MPS is depicted by a savings line: a sloped line created by plotting change in savings on the vertical y-axis and change in income on the horizontal x-axis.

• Marginal propensity to save (MPS) is the proportion of an increase in income that gets saved instead of spent on consumption.
• MPS varies by income level and is typically higher at higher incomes.
• MPS helps determine the Keynesian multiplier, which describes the effect of increased investment or government spending as an economic stimulus.

Suppose you receive a $500 bonus with your paycheck. You suddenly have $500 more in income than you did before. If you decide to spend $400 of this marginal increase on a new business suit and save the remaining $100, your marginal propensity to save is 0.2 ($100 change in saving divided by $500 change in income).

Given data on household income and household saving, economists can calculate households’ MPS by income level. This calculation is important, because MPS is not constant; it can vary by income level. Typically, the higher the income, the higher the MPS, because as wealth increases, so does the ability to satisfy needs and wants, and so each additional dollar is less likely to go toward additional spending. However, the possibility remains that a consumer might alter savings and consumption habits with an increase in pay.

Naturally, with an increase in salary comes the ability to cover household expenses more easily, allowing for more leeway to save. A higher salary also brings access to goods and services that require greater expenditures. This may include the procurement of higher-end or luxury vehicles or relocation to a new, pricier residence.

If economists know what consumers’ MPS is, they can determine how increases in government spending or investment spending will influence saving. MPS is used to calculate the expenditures multiplier using the following formula:

The expenditures multiplier tells us how changes in consumers’ MPS influences the rest of the economy. The smaller the MPS, the larger the multiplier and the more economic impact a change in government spending or investment will have. 

The marginal propensity to consume (MPC) is the complement to MPS; added together they should always equal one.

The other side of MPS is the marginal propensity to consume (MPC), which shows how much a change in income affects purchasing levels.

Using the above example, where you spent $400 of your $500 bonus, MPC is 0.8 ($400 divided by $500).

If you add MPC and MPS, the result should always equal one, making MPC the complement to MPS.

MPS refers to the amount of a raise in income that a person saves as opposed to spends.

MPS can be used to understand how government spending and investment may influence saving and what the economic impact of the spending and investment might be.