Suppose you receive a pay raise at work. Chances are, you will spend some of the additional money you earn, buying things you could not afford previously. You also may save some of the additional for the future. Economists have mathematical measures for studying how changes in income change a person's consumption and saving habits. They call them the "marginal propensity to consume" and "marginal propensity to save."
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The marginal propensity to consume (MPC) is the proportion of additional income that a person uses for consumption. Economists calculate the MPC by dividing the change in consumption by the change in income. For example, if a person receives £65 in additional income and spends £45 of it in additional consumer spending, then the MPC equals 0.70.
The marginal propensity to save (MPS) is the flipside of the MPC and is the proportion of additional income that a person dedicates to saving. To calculate the MPS, divide the change in saving by the change in income. If the same person in the earlier example receives £65 of additional income and saves £19 of it, then the MPS equals 0.30.
The MPC and MPS measures in economics have their roots in the work of early 20th century economist John Maynard Keynes, who contended that a psychological law of consumer behaviour separated his economic theories from the classical perspectives of his time. This psychological law, according to Keynes, held that people have the propensity to spend most, but not all, of the additional income they receive.
Changes in consumption and saving, as measured by the MPC and MPS, ripple throughout the economy, laying the foundation for what economists call the "multiplier": the interaction between consumption and production that leads to changes in aggregate economic output, or gross domestic product. With a larger MPC, consumption is higher, generating more income for producers, who increase production. The additional production raises incomes, fuelling even more consumption and saving.
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