What is Marginal Propensity to Save (MPS)?

Since time immemorial, economists have sought out the most effective ways to quantify things that are generally measured by quality. Some of these concepts include utility, creditworthiness, mortgage affordability, and saving habits, to name a few. While the debt-to-income ratio metric adequately measures debt, saving finds its SI unit in Marginal Propensity to Save (MPS).

MPS is the ratio of an income rise used for saving, not for expenses. Automatically, if the income reduces, the marginal propensity to save generally reduces. Also, this means that higher incomes generally have higher MPS while lower incomes may have lower MPS.

Formula to calculate marginal propensity to save

MPS is the gradient or slope of the graph containing savings and income. Savings are plotted on the y-axis, while income is on the x-axis. The change in savings in relation to the change in income is the MPS, which can be calculated as the gradient usually is:

MPS = Change in savings / Change in income

For instance, an individual X earning $5,000 monthly and saving $2000 has an MPS of 0.4. This means that for every dollar X earns, 40 cents is directed towards saving.

Implications of MPS

What MPS means is that your saving culture is quantified. When describing how well or poorly you save, you can have an actual numerical metric that can be ascertained and compared with others. Also, by observing your MPS on a graph, you can track your progress over the years. You can tell if your savings have increased according to your income. It helps you plot best practices moving forward that will improve your MPS.

MPS vs MPC

The Marginal Propensity to Consume (MPC) is the opposite of MPS. MPC is the ratio of consumption against income. It tends to answer the question, “If individual X receives a 100% boost in income, how much of that new income are they ready to spend?”

A low MPC means that the individual spent less money and saved more, which means that a low MPC is parallel to a high MPS. This also means that in a closed economy, if MPS is 0.4, then MPC is 0.6, which means that the individual consumes more than they spend.

Generally, in a closed economy:

MPS + MPC = 1

MPS = 1 – MPC

MPC = 1 – MPS

A good example of these two concepts is: Individual X earns $5000 and spends $450 on utilities, $300 on repaying debt, and $100 on general expenses. He saves the rest. Then:

MPC = ($450 + $300 + $100) / $5000

MPC = 0.17

If he saves the rest, which is an example of converting this into a closed economy, where if we don’t spend money, we save it:

MPS = 1 – 0.17

MPS = 0.83

The individual has great saving habits.

Another way to calculate the MPS for this case would be:

MPS = change in savings ÷ change in income

MPS = ($5000 - $850) / $5000

MPS = 0.83

The Keynesian multiplier

A multiplier automatically affects every related variable in economics when it is put into action. The change is proportional to the multiplier. The Keynesian multiplier theory argues that supply will not always create its demand; sometimes, it needs a stimulus. MPS determines this Keynesian multiplier.

The multiplier is calculated as:

Multiplier (k) = 1/ (1-MPC) = 1/ MPS

The implication is that the higher your MPS, the lower the multiplier. This means that there is more induced saving and less consumption.

For instance, if your MPS = 0.2, then the multiplier effect is 5, and if MPS = 0.9, then the multiplier effect is 1/0.9 = 1.11.

Factors that may affect your marginal propensity to save

The following are some of the reasons why your MPS is the way it is:

• Your income amount
• Saving habits
• Spending habits
• Current activities, for instance, while studying, your MPS may be zero because a student will mostly be borrowing.
• Risk preferences. While some individuals may be open to investing and taking on risks, others may prefer to save any income that comes their way.
• The ‘I’ll save someday’ mentality. Most Gen Z will prefer to spend money in their youth days then save up when they are a bit more mature.

How to increase your marginal propensity to save

Perhaps the best way to improve your MPS is to have good money habits. Invest in making your financial discipline strong and sturdy. The best way to understand this is to consider how you can improve your saving culture.

One of the ways to increase your MPS is to record and track all your expenses. By reducing the amount of your income that goes towards settling bills and paying for debts, you aim all that money towards your savings account. When you record all your monthly purchases, it becomes easier to cut down on unnecessary stuff. You could use online apps to help you with managing your spending.

Prioritize saving, even in your budget allocation and planning. Have a minimum percentage of your income set aside for saving, and do not change it downward; only go up from there. Set both short-term and long-term saving goals and stick to them. The best thing about saving is that as painful as it is to set the money you need aside, it remains yours and can be used in the future. It could also improve your creditworthiness.

Finally, pat yourself on the back for the small wins. Saving is not a merry ride; it could be utterly devastating knowing you have money, but you shouldn’t use it. Congratulate yourself the first time you save, and do so progressively. Allocate a percentage of money to treat yourself once you save a certain amount, like paying yourself a commission. It will ultimately make you look forward to saving without any compulsion whatsoever.