Marginal Propensity to Save (MPS) and Multiplier Effect

The marginal propensity to save (MPS) is the proportion of additional income that a person saves rather than spends. It represents the change in saving resulting from a change in income. The multiplier effect, on the other hand, refers to the magnification of an initial change in spending or investment into a larger change in national income.

Relationship between MPS and Multiplier

The value of the multiplier is determined by the formula: Multiplier = 1 / MPS. It represents the ratio of the change in national income to the initial change in spending or investment. Therefore, if the MPS decreases, the value of the multiplier will increase.

Explanation

When the MPS decreases, it means that people are saving a smaller proportion of their additional income and spending a larger proportion. This implies that the initial change in spending or investment will have a bigger impact on the overall economy, leading to a larger increase in national income.

The decrease in MPS indicates that people are more inclined to spend rather than save, which stimulates economic activity. As people spend more, businesses generate higher revenues, which then leads to increased wages and profits. This in turn creates a cycle of increased spending, further boosting economic growth.

The increase in spending resulting from a lower MPS has a multiplying effect on the economy. Each additional dollar spent leads to an increase in income, which is then spent again, and so on. This process continues until the cumulative increase in income matches the initial change in spending or investment.

Example

For example, let's assume that the MPS decreases from 0.4 to 0.2. Initially, if there is a $100 increase in spending, the change in national income would be calculated as follows:

Multiplier = 1 / MPS = 1 / 0.4 = 2.5

Change in National Income = Multiplier × Initial Change in Spending
Change in National Income = 2.5 × $100 = $250

However, if the MPS decreases to 0.2, the new multiplier would be:

Multiplier = 1 / MPS = 1 / 0.2 = 5

Change in National Income = Multiplier × Initial Change in Spending
Change in National Income = 5 × $100 = $500

As demonstrated in this example, the decrease in MPS from 0.4 to 0.2 leads to an increase in the value of the multiplier from 2.5 to 5. This means that the change in national income resulting from the initial change in spending is now twice as large.

Explanation:
When the marginal propensity to save (MPS) decreases, it means that individuals are saving a smaller proportion of their additional income. In other words, they are spending a larger proportion of their additional income. This has an impact on the value of the multiplier.

The multiplier:
The multiplier is a concept in economics that measures the change in overall spending resulting from a change in autonomous spending (such as investment or government spending). It is represented by the formula:

Multiplier = 1 / (1 - MPC)

Where MPC is the marginal propensity to consume, which is equal to 1 - MPS.

Relationship between MPS and the multiplier:
The multiplier is inversely related to the MPS. This means that as the MPS decreases, the value of the multiplier increases. There are a few reasons for this:

1. Increased spending: When the MPS decreases, individuals are saving less and spending more of their additional income. This increased spending leads to a larger increase in overall spending in the economy.

2. Multiplier effect: The multiplier works by generating additional rounds of spending as the initial increase in spending leads to income for others, who in turn spend a portion of that income. As the MPS decreases, more income is spent and less is saved, resulting in a larger multiplier effect.

3. Aggregate demand: The multiplier affects aggregate demand, which is the total spending in the economy. As the value of the multiplier increases due to a decrease in MPS, aggregate demand also increases. This can have a positive impact on economic growth and employment.

Conclusion:
In summary, when the marginal propensity to save decreases, the value of the multiplier increases. This is because individuals are saving a smaller proportion of their additional income, leading to increased spending and a larger multiplier effect. This has positive implications for aggregate demand and can contribute to economic growth.