Marginal Propensity To Consume - MPC

From the perspective of measuring income, or wealth, or savings, or any other way dough is accumulated by individuals and companies...the manner in which the dough is grown is kind of a neutral event. That is, people can make money, whether it be from a steady paying job with a W2 paycheck, or via the unemployment benefit checks courtesy of the working taxpayers after having been laid off, or by way of dividend income from stock investments, or interest income from loans, or by being paid as contractors for a dime an hour working for the kindly loving people at Shmoop.

When humans make money, they usually put some of it away in a savings account, or invest in assets like stocks and bonds. The rest? They spend it. Or maybe they spend first, and whatever is left over is called “savings.”

And there’s a natural balance here. Someone just scraping by, subsisting on ramen and renting part of a trailer in central Mississippi on 15 grand a year from their mosquito-circus-box-office-sales isn’t going to save much. If anything. And, in fact, people who live below the poverty line actually accumulate incrementally more debt, in a vicious cycle...such that their skimpy, occasional savings all end up going toward paying off previous debts, rather than buying comfort for the future.

At the other end of the spectrum are high salaried neurosurgeons and bankers who make $5 million a year, only to pay $2 million plus in taxes and keep $3 million. Were it not for those high tax paying top-end-earners in society, there’d be no money for little benefits to the central Mississippi dude. And on their $3 million of after-tax income, maybe they spend a million bucks to live. Private school for the kids. Maybe a fat mortgage payment. Alimony for wife #2.

The central Mississippi Trailer Dude will take the $5 you give him and spend it all to buy a nice hot meal. Jeff Bezos, on the other hand, saves a ton of money in various forms. He gets like $4 million a year in salary for running the largest retailer in the world.

But that money is kind of a joke compared to the $100 billion plus he owns in stock in the company. So he is some 250 times more incentivized to make the stock go up over time than he is just taking another million or three in salary.

The gist, however, is that the marginal income of fighting for, say, that extra million bucks...means nearly nothing to him. He has too many homes and a big jet and not much else to spend the money on. So he just saves the remainder...or in actual real life, just gives it away to charities, or spends it on pet projects like colonizing Mars as part of his "thank you" to the world for making him so rich by buying Prime.

When assessing the trade-off between spending and saving, economists focus on marginal dollars. Recall that a marginal dollar is the very next dollar you earn. The last one. After earning $58,983 in a year where you earned $58,984, the marginal dollar is the $58,984th. So for each marginal dollar you get, you’re likely to save some of it and spend the rest, if you’re a normal, non-superhero human like Bezos.

These behaviors are characterized by the Marginal Propensity to Save and the Marginal Propensity to Consume. Propensity is just a super fancy word for likelihood, or inclination...so you could say that Oxbridge-educated British people have a propensity to use excessively extravagant and florid language.

The higher an individual’s MPS, the more likely they are to save their next dollar. The highly productive, educated, hard-working big earners in society earn more than they actually “need,” so they save the rest.

The same is true for MPC, which implies that, the higher your MPC, the more likely you are to spend your next dollar, or the more of that next dollar you are likely to spend. So if you get an end-of-year bonus of $1,000 after tax (meaning the gross total bonus was, say, $1,600), you might be able to go to a nice dinner, buy some new clothes, and maybe get a subscription to your favorite magazine, because…well...you like it old school, and the free stuff just isn’t cutting it.

If all that tallies up to $650, and you put the remaining $350 into savings, the portion of the extra income you got, or your MPC, is 0.65, and your marginal propensity to save, or MPS, is 0.35. Since you save whatever you don’t end up spending, you know for sure that MPC + MPS = 1.

A poor person is much more likely to spend a dollar than a rich person, so some make the argument that increasing transfer payments, or reducing taxes for the poor, bolsters the economy for doing the same thing to the rich.

George from Podunk, Iowa sits in front of his dining room table covered in all of his bills, thinking to himself, “How did this happen?” His wife left him with two kids who both need dental work and heavy SAT tutoring, and have no prayer of a getting a new backpack, let alone hopping on the new fad of sneakers with a wheel in the heel. Any money that comes in to George gets spent immediately on food, keeping their home from freezing over, and paying off the mortgage on their house. In other words, George’s MPC is near 1, since money that comes in has to be spent on essentials.

Contrast George with Bezos’ spending habits, and the $150 billion fortune stored in his Amazon stock, and uh...you’ll get a very different picture.