Pay raises and bonuses are always welcome sights in a paycheck. Whether you're a spender or a saver, an increase in your income also brings an increase in the amount of money you choose to spend or save. It's the proportion of your income increase that's delegated to spending or saving that determines your marginal propensity to consume (MPC) or marginal propensity to save (MPS). And even if you're not a math genius, calculating these two equations is a breeze.
Marginal Propensity to Consume
Unless you save all of your pay increase, you'll spend at least a portion of your newly available funds. Whether you go on a shopping spree for new clothes or you buy a new car, the portion of your increased income that's spent on goods or services is your marginal propensity to consume definition.
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Although it may seem counterintuitive, MPC typically is lower at higher income levels. Even though higher income consumers may have more disposable income to purchase goods and services, they can more easily meet these needs with less income. Lower income consumers have to use a greater part of their income to meet basic needs.
Marginal Propensity to Save
On the flip side, the portion of your increased income that you save, instead of consuming goods and services, is your MPS. Both MPS and MPC vary, depending on consumer income levels. Because consumers at higher income levels can meet their living expenses easier than consumers at lower income levels, they have more opportunities for saving with each pay increase. This economic principle results is a higher MPS at higher income levels.
MPS also represents a concept called economy leakage, which is the amount of income that consumers do not put back into the economy by purchasing goods and services.
Keynesian Macroeconomics Multiplier
Both MPC and MPS are vital components as multipliers in the Keynesian macroeconomics theory. As consumers spend more, the national gross domestic product (GDP) also increases. When private consumption expenditures also include investments and net government spending (net spending equals total spending minus tax revenue), the GDP can increase even beyond the actual amount of expenditures. According to Keynesian theory, when the GDP increases, government spending increases, which increases consumer income and encourages them to spend more.
How to Calculate MPC
The simple equation for calculating MPC is:
(Change in consumption) / (Change in income)
Putting real dollars to this equation, if you receive a $200 bonus in addition to your regular pay (which represents your marginal increase in income), and you spend $120 of it, your MPC is 0.6 ($120 divided by $200).
How to Calculate MPS
The simple equation for calculating MPS is:
(Change in saving) / (Change in income)
Putting real dollars to this equation by using the same numbers in the above example for calculating MPC, if you receive a $200 bonus in addition to your regular pay, and you save $80 of it (you spent $120 of it), your MPS is 0.4 ($80 divided by $200).
The MPC plus MPS (for the same pay increase and same spending/savings portions) always equals 1. Using the two examples above for calculating MPC and MPS, their sum equals 1 (0.6 plus 0.4).