Here are some example scenarios showing how to calculate MPS and how to calculate MPC.
Example 1
Last year, Shireen earned $40,000 and was able to save $5,000. This year, she received a raise, increasing her salary to $45,000, which allowed her to save $6,000. What is her marginal propensity to save?
The MPS formula provided above can be applied, after identifying the year-over-year change in Shireen's income and savings. Her change in income was:
$$\Delta I = \$45,\!000 - \$40,\!000 = \$5,\!000 $$
The corresponding change in her savings was:
$$\Delta S = \$6,\!000 - \$5,\!000 = \$1,\!000 $$
Shireen's MPS was
$$MPS = \dfrac{ \Delta S}{\Delta I} = \dfrac{ \$1,\!000 } {\$5,\!000 } = 0.20 = 20\% $$
Shireen was able to save 20% of the additional income she earned, or 20 cents out of every additional dollar. The MPS can be interpreted visually as the slope between initial and final points on a graph of savings versus income.
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Example 2
Steve earns a regular bi-weekly pay check of $2,586.50. At the end of his most recent pay period, he received a $400 performance bonus, of which he spent $249.53 in a shopping spree. What is his marginal propensity to consume?
The change in Steve's income is only the amount of the bonus, since the regular, total amount represents his current level of income and not a change in circ*mstance. Stated symbolically:
$$\Delta I = \$400 $$
The corresponding change in consumption was
$$\Delta C = \$249.53 $$
Steve's MPC was
$$MPC = \dfrac{ \Delta C}{\Delta I} = \dfrac{ \$249.53 } {\$400 } \approx 0.62 = 62\% $$
Steve spent about 62% of the bonus income he earned, or 62 cents out of every additional dollar.
Analyzing MPC and MPS
Shireen's and Steve's MPC and MPS represent their preference to either spend or save any additional income they earn. Since all income is either spent or saved, once one propensity is calculated, the other can be found using the complementary condition:
$$MPC + MPS = 1 $$
So, to complete the analysis of the examples above, Shireen's MPC was
$$MPC = 1 - MPS = 1 - 0.20 = 0.80 = 80\% $$
and Steve's MPS was
$$MPS = 1 - MPC = 1 - 0.62 = 0.38= 38\% $$
Saving is more difficult for lower income individuals, as any additional income may be needed to maintain their standard of living. Higher income allows for greater spending on non-essential consumption, but also for saving money for the future. In general, higher income correlates with a higher propensity to save and lower propensity to spend, even though their total spending could be much higher.
The examples of Steve and Shireen are consistent with this trend. Steve's regular annual income (assuming 26 bi-weekly pay periods) comes to $67,249, compared to Shireen's $45,000, after her raise. Steve's propensity to save was 38%, versus Shireen's 20%.
An individual's MPC and MPS does of course depend on their particular circ*mstances. There are many factors other than simply total income that may affect someone's tendency to spend or save. Some of these other factors include:
- Interest rates: higher interest rates on bank accounts may encourage customers to save rather than spend their money.
- Inflation: high inflation may encourage immediate consumption, particularly of major purchases, since prices are expected to rise in the future.
- Consumer confidence: general economic sentiment, either positive or negative, may influence individual decisions.
- Demographic factors such as age and culture can carry over into spending and saving patterns.
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