The full form of MPS is Marginal Propensity to Save. The Marginal Propensity to Save (MPS) holds significant importance in economics as it quantifies the portion of additional income that individuals or households choose to save rather than spend.
This concept plays a critical role in comprehending consumer behaviour, fiscal policies, and the overall stability of the economy.
Calculation of MPS
The calculation of MPS involves dividing the change in savings by the change in income. Mathematically, MPS is represented as:
MPS = Change in Savings / Change in Income
For instance, if a household experiences a $100 increase in income and decides to save $20 of it, the MPS would be 0.2 or 20%. This implies that for every additional dollar earned, the household saves 20 cents.
Significance of MPS
MPS significantly influences the overall economic activity within a country. When MPS is higher, it indicates that a substantial portion of people’s income is being saved, which, in turn, reduces consumption spending. This can potentially slow down economic growth as the decreased spending dampens the demand for goods and services.
Conversely, a lower MPS suggests that individuals are spending a larger proportion of their income, which can have a stimulating effect on economic growth. Higher consumption creates increased demand for goods and services, thus driving production and investment in the economy.
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MPS and Fiscal Policies
Governments frequently employ MPS as a crucial factor in formulating fiscal policies aimed at influencing economic activity. For instance, during economic recessions or slowdowns, policymakers might implement tax cuts or increase public spending to enhance consumer spending.
Lower taxes result in individuals having more disposable income, leading to a decrease in MPS and an increase in consumption, ultimately stimulating economic growth.
On the contrary, when faced with inflation or excessive economic growth, policymakers may opt to increase taxes or reduce government spending to temper the economy. Higher taxes decrease disposable income, leading to a rise in MPS and a decrease in consumption, which helps control inflationary pressures.