What is the relationship between the marginal propensity to consume and the marginal propensity to save, and how do they affect GDP?

Expert Answers

An illustration of the letter 'A' in a speech bubbles

The marginal propensity to consume (MPC) is defined as the portion of each dollar a household receives through a raise in pay that is used to purchase goods and services or is otherwise spent.

The marginal propensity to save (MPS) is defined as the portion of each dollar a household...

Unlock
This Answer Now

Start your 48-hour free trial to unlock this answer and thousands more. Enjoy eNotes ad-free and cancel anytime.

Start your 48-Hour Free Trial

The marginal propensity to consume (MPC) is defined as the portion of each dollar a household receives through a raise in pay that is used to purchase goods and services or is otherwise spent.

The marginal propensity to save (MPS) is defined as the portion of each dollar a household receives through a raise in pay that is put away as a provision for the future (what we call "savings").

The notion of MPC versus MPS, metrics crucial to Keynesian economics, reveals the level at which consumer demand and extra income fuel the economy.

It's critical to note the relationship between MPC and MPS: they are flip sides of the same coin. MPC + MPS = 1. In other words, if 69 cents of an extra dollar is spent, than 31 cents must be saved.

Gross domestic product (GDP) is affected by this relationship because in consumer-driven societies where MPC is higher, the increased levels of consumption drive the providers of goods and services to increase output in order to satisfy the demand.

Any change in the GDP as a result of MPC and MPS is defined by the GDP multiplier, which can be expressed as follows: 1/(1-MPC).

Approved by eNotes Editorial Team
An illustration of the letter 'A' in a speech bubbles

Marginal propensity to consume (MPC) is the fraction of the extra income that if earned by a person is likely to be consumed. The marginal propensity to save is the fraction of the extra income earned that is likely to be saved.

As an example, if a person who normally earns $10,000 per month gets an extra bonus of $2000 in January. And $1600 out of the $2000 is consumed, the MPC is equal to 1600/2000 = 0.8. The marginal propensity to save (MPS) is equal to 1 – MPC or 1 - 0.8 = 0.2 in this case.

Now GDP in its standard use in economics is the sum of private consumption (C), gross investment (I), government spending (G) and net exports (X). If any of these terms increases we see an increase in GDP equal to the initial GDP multiplied by 1/ (1-MPC) or 1/MPS. So a larger propensity to consume increases GDP to a larger extent for the same change in either of C, I, G or X.

Approved by eNotes Editorial Team