With an increase in income, any person begins to spend more and save for something. It would seem that in practice everything is quite simple - more money, which means more than anything else. In fact, in economics there are a number of concepts, theories, various formulas and relationships that describe, calculate and explain this phenomenon. These include the propensity to consume (marginal, average), to save, Keynesian basic psychological law, etc. Knowing and understanding these economic terms and laws makes it possible to differently assess habitual phenomena, as well as the causes of their occurrence and patterns, to which they bring.
The founder
The concept of “marginal propensity to consume and save” appeared in the 20-30s. last century. He was introduced into economic theory by the Englishman John Maynard Keynes. By consumption, he meant the use of various goods to satisfy the physical, spiritual or individual needs of one person or group of persons. Keynes indicated by saving that part of the income that was not spent on consumption, but was saved in order to be used in the future with greater benefit. The economist also revealed the basic psychological law, according to which the growth of income will certainly increase consumption (the range of goods is expanding, cheaper goods are being replaced by more expensive goods, etc.), but not so fast (not proportionally). In other words, the more a person or group of people receives, the more they spend, but also the greater the amount they have left for savings. Based on his theory, Keynes developed concepts such as the average and marginal propensity to consume (the formula for calculating it was also derived), as well as the average and marginal propensity to save and the methodology for calculating it. In addition, this prominent economist has identified and established a number of relationships between these concepts.
Consumption calculation
The marginal propensity to consume is equal to the ratio of changes in consumption to changes in income. It represents the share of changes in consumer spending per unit of income that led to them. This term is usually denoted by the Latin letters MPC - short for English marginal propensity to consume. The formula is as follows:
MPC = Changes in consumption / changes in income.
Calculation of savings
Like propensity to consume, marginal propensity to save is calculated by the ratio of changes in savings to changes in income. It expresses the share of changes in savings, which accounts for each monetary unit of additional income. In the literature, this concept is denoted by MPS - an abbreviation from English marginal propensity to saving. The formula in this case is as follows:
MPS = Changes in savings / changes in income.
Example
Calculations of indicators such as marginal propensity to consume or savings are quite simple.
Baseline: the consumption of the Ivanov family in October 2016 amounted to 30,000 rubles, and in November - 35,000 rubles. Income received in October 2016 is 40,000 rubles, and in November 60,000 rubles.
Savings 1 = 40,000 - 30,000 = 10,000 rubles.
Savings 2 = 60,000 - 35,000 = 25,000 rubles.
MPC = 35,000-30,000 / 60,000 - 40,000 = 0.25.
MPS = 25,000 - 10,000 / 60,000 - 40,000 = 0.75.
Thus, for the Ivanov family:
The marginal propensity to consume is 0.25.
The marginal propensity to save is 0.75.
Relationships and Dependencies
The marginal propensity to consume and save per one monetary unit with the same initial data should total one. It follows that none of these values as a result of calculations can be greater than 1. Otherwise, you need to look for errors or inaccuracies in the source data.
In addition to these factors, in addition to income, other factors may also influence:
- Wealth accumulated by households (securities, real estate). The larger their value, the lower the level of savings and the higher the rate of consumption. This is due to the costs of maintaining the property, and the maintenance of a certain standard of living, and the absence of an acute need for hoarding.
- The growth of a variety of taxes and fees can significantly reduce both the volume of savings and the size of expenses.
- An increase in supply on the market contributes to an increase in consumption and, consequently, a decrease in the level of accumulation. This is especially acute caused by the appearance of a new product or service (as a result of scientific and technological progress), since a new need arises that did not exist before.
- Economic expectations can trigger the growth of both one indicator and the second. For example, the expectation of a rise in price of any product can provoke its excessive consumption (procurement for the future), which will negatively affect accumulations.
- An unexpected significant increase in prices will have a different effect on the consumption and savings of different social groups.
Analysis Features
There are several points that should be considered when analyzing indicators such as the propensity to consume marginally and also to save. What are these moments? Firstly, if the marginal propensity to consume is almost one, then there is a lack of income or a low level of its growth compared with the growth of physical and spiritual needs. Most often, this picture develops in developing countries with unstable economies or during times of financial and economic crisis.
Secondly, the calculation of these indicators for individuals or families for the economy of a country or industry is uninformative, therefore, most often they consider a certain combination of consumption and savings (households, social groups, etc.). At the same time, a number of Keynesian theory provisions are used. For example, consumption is a function of disposable income.
Thirdly, the analysis usually uses indicators not of two periods (as indicated in the calculation example), but of the values of longer periods of time. Then the results are displayed graphically, which makes it possible to more clearly study and analyze the dynamics. The constructed graphs are called Keynesian functions and often appear in the analysis of various economic phenomena.