AP® Macroeconomics · Unit 3 · Topic 3.2
Marginal Propensity to Consume and Save
Marginal propensity to consume and save describe how a household splits each new dollar of income between spending and saving, and that split determines how powerful the spending multiplier is.
Give a household an extra dollar of disposable income and it does one of two things with it: spend it or save it. The marginal propensity to consume, MPC, is the fraction spent. The marginal propensity to save, MPS, is the fraction saved. Because every dollar goes somewhere, MPC + MPS always equals 1. This split matters enormously for the economy because one person's spending is another person's income. A dollar spent gets re-spent, respent again, and so on, and the size of that chain reaction is the spending multiplier, equal to 1 divided by MPS.
A high MPC means a small MPS, which means a small denominator and a large multiplier: stimulus spending ripples further through the economy. A low MPC means a large MPS, a small multiplier, and a stimulus that fizzles out fast. This is why policymakers care so much about where a dollar of income or a tax cut actually goes, not just how large it is. A trillion-dollar stimulus with a low MPC can move the economy less than a smaller one aimed at high-MPC households.
This idea sits right before the multiplier formula and the aggregate demand shifts that follow it in the unit. MPC and MPS are the raw ingredients; the multiplier is what you bake with them, and it is what tells you how far an initial shock to spending pushes the aggregate demand curve. Get the propensities right and the rest of the short-run model falls into place.
Key terms
- Marginal propensity to consume (MPC)
- The fraction of an extra dollar of disposable income that a household spends.
- Marginal propensity to save (MPS)
- The fraction of an extra dollar of disposable income that a household saves, equal to 1 minus MPC.
- Spending multiplier
- The factor, equal to 1/MPS, by which an initial change in spending ultimately changes total output.
- Disposable income
- Income households have left to spend or save after taxes are paid.
Watch it explained
- How it worksHow do the marginal propensity to consume and to save split every new dollar of income?
- Worked exampleFind the MPC when disposable income rises 400 dollars and consumption rises 340 dollars.
- Common mistakeWhy isn't a high saving rate automatically good for output in the short run?
- Going furtherWhat happens to that split when households start paying down debt with extra income?
Check yourself
End of topic.