by The concepts of the propensities of consumption and saving are central to understanding how households allocate their income between spending and saving. These concepts describe the proportion of income that households consume and save, respectively.
The propensity to consume (MPC) is the fraction of a household’s disposable income that is spent on consumption. It is calculated by dividing the change in consumption spending by the change in disposable income. For example, if a household’s disposable income increases by $100 and its consumption spending increases by $80, the MPC would be 0.8 ($80/$100).
The MPC is an important concept because it influences the multiplier effect of changes in government spending or investment. The multiplier effect refers to the idea that an initial change in spending can have a larger impact on the economy as a whole as it leads to additional rounds of spending and income. The size of the multiplier effect depends on the MPC, as a higher MPC means that a larger proportion of any increase in spending will be circulated back into the economy.
The propensity to save (MPS) is the fraction of a household’s disposable income that is saved. It is calculated by dividing the change in savings by the change in disposable income. For example, if a household’s disposable income increases by $100 and its savings increase by $20, the MPS would be 0.2 ($20/$100).
The MPS is important because it affects the level of investment in the economy. When households save, they may deposit their savings in a bank, which can then lend the money out to businesses for investment purposes. Therefore, a higher MPS can lead to lower levels of investment in the economy, as there is less money available for businesses to borrow.
It is important to note that the MPC and MPS are not fixed values, but can vary depending on a number of factors. For example, if households expect their income to increase in the future, they may choose to save less and spend more in the present, leading to a higher MPC and lower MPS. On the other hand, if households are uncertain about their future income, they may choose to save more as a precaution, leading to a lower MPC and higher MPS.
In addition, the MPC and MPS can vary across different income levels and demographic groups. For example, households with lower incomes may have a higher MPC, as they may need to spend a larger proportion of their income on necessities such as housing and food. Similarly, older households may have a higher MPS, as they may be saving for retirement or other future expenses.
