Marginal Propensity to Consume (MPC) vs Marginal Propensity to Save (MPS)
Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) are two Aggregate Demand & Supply concepts in AP Economics that students often mix up. The marginal propensity to consume is the fraction of each additional dollar of disposable income that households spend. The marginal propensity to save (MPS) is the fraction of each additional dollar of disposable income that households save. Here is how they compare side by side.
It ranges between 0 and 1 and determines the size of the spending multiplier. A higher MPC means more of any new income is re-spent, amplifying changes in aggregate demand. The MPC and the marginal propensity to save (MPS) always sum to 1.
It ranges between 0 and 1 and, together with the marginal propensity to consume, always sums to 1. A higher MPS means a smaller spending multiplier. It measures how much of new income leaks out of the spending stream.
MPC vs MPS: Where the Next Dollar Goes
| Marginal propensity to consume | Marginal propensity to save | |
|---|---|---|
| Definition | Fraction of an additional dollar of disposable income that is spent | Fraction that is saved |
| Formula | Change in consumption divided by change in disposable income | Change in saving divided by change in disposable income |
| Range | Between 0 and 1 | Between 0 and 1 |
| They sum to | 1 always, since every extra dollar of disposable income is either spent or saved | 1 |
| Effect on the spending multiplier | Higher MPC means a larger multiplier | Higher MPS means a smaller multiplier |
| Multiplier formula | 1 divided by (1 minus MPC) | 1 divided by MPS |
Two names for the same split
Every additional dollar of disposable income is either spent or not spent, and whatever is not spent is saved. So the two propensities are complements: MPC plus MPS equals 1. If a household spends 80 cents of an extra dollar, MPC is 0.8 and MPS is 0.2. Note that these are MARGINAL, about the NEXT dollar, not the average of all income. A household can save 5 percent of its total income while saving 30 cents of an unexpected extra dollar, and questions sometimes give you total figures to see whether you compute the change rather than the level.
The multiplier, and why MPC drives it
When someone spends, that spending becomes another person's income, who then spends a fraction of it, and so on. The total effect on real GDP from an initial injection is the spending multiplier, equal to 1 divided by (1 minus MPC), which is the same as 1 divided by MPS. With an MPC of 0.8 the multiplier is 5, so 100 million dollars of new government spending eventually raises real GDP by 500 million. With an MPC of 0.5 it is only 2. This is why the same fiscal package has very different effects in different economies, and why questions about stimulus effectiveness usually turn on the MPC. Check your arithmetic at /calculate/spending-multiplier.
The tax multiplier is smaller, and this is the trap
A tax cut does not enter the economy at full force the way government spending does. The first thing that happens is that households receive extra disposable income, and they save part of it, so only the MPC fraction is spent in the first round. The tax multiplier is therefore negative MPC divided by (1 minus MPC), which is smaller in absolute value than the spending multiplier by exactly 1. With an MPC of 0.8, the spending multiplier is 5 while the tax multiplier is negative 4. That is a standard exam comparison: dollar for dollar, government spending moves aggregate demand more than a tax cut, and the reason is that the first round of a tax cut leaks into saving.
Frequently asked questions
What is the difference between MPC and MPS?
The marginal propensity to consume is the fraction of an additional dollar of disposable income that gets spent; the marginal propensity to save is the fraction that gets saved. Since every extra dollar is either spent or saved, MPC plus MPS equals 1.
How do you calculate the spending multiplier from MPC?
The spending multiplier is 1 divided by (1 minus MPC), which is the same as 1 divided by MPS. With an MPC of 0.75 the multiplier is 4, so an initial 50 million dollars of new spending would eventually raise real GDP by 200 million, holding other things constant.
Why is the tax multiplier smaller than the spending multiplier?
Because a tax cut enters the economy as extra disposable income, and households save part of it before any of it is spent. Only the MPC fraction reaches the spending stream in the first round. The tax multiplier is negative MPC divided by (1 minus MPC), exactly one less in absolute value than the spending multiplier.
Live Fiscal Policy graph. Drag the curves, or open the full version.
Related comparisons
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