Marginal Propensity Calculations for Personal Finance

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Some calculations used by macroeconomic experts can be adapted to the field of microeconomics and even personal finance; such is the case with marginal propensity to consume and marginal propensity to save.

In consumer societies such as the United States, the marginal propensity to consume (MPC) can be used to recognize socioeconomic trends and consumer behavior in reaction to major events such as inflation, deflation, income growth, income inequality, employment levels, recessions, depressions, and market corrections.

In late 2016, MPC in the United States was calculated to be between 90 and 98 percent; what this means is that the rate of personal savings is quite low when compared to other developed nations and global economic leaders.

MPC calculations at macroeconomic levels are very complex because they take into account aggregate and statistical data. On a personal finance level, calculating MPC is a very simple matter:

* MPC = Income Consumed or Spent / Income Earned * 100

The result of the formula above is expressed as a percentage, but it can also be expressed as a ratio. Let’s find, for example, the MPC of a Nebraska family that enjoys a household income of $100,000 per year but spends most of it:

$99,000 / $100,000 * 100 = 99 percent MPC

MPC is more realistic when net income is utilized instead of gross income. For this Nebraska family, the MPC situation is alarming since they are above the high end of the national range.

Marginal Propensity to Save (MPS) is also a very simple calculation. Let’s say a Montana family also enjoys $100,000 in annual household income, and they are able to put away $50,000 in the bank:

$50,000 / $100,000 * 100 = 50 percent MPS

Again, it is better to use gross income when calculating MPS. This calculation is often referred to as the household savings or personal savings rate, and it is closely watched by global entities such as the World Bank and the Organization for Economic Development and Cooperation (OECD).

Among OECD countries, the United States does not have the lowest household savings rate, that would be Denmark, a country where the savings rate is actually negative. Whereas Americans have a household savings rate of 4.9 percent, Danish families have a dismal rate of -4.1 percent; however, it should be noted that the levels of social welfare, employment and access to adequate healthcare are considerably higher than in the U.S.

When it comes to estimating an ideal MPS rate, the sky is the limit. Personal finance planners often tell their clients to save up as much as possible. Democratic Senator Elizabeth Warren is advised by a team of economists who believe that the ideal MPS rate for American families should be at least 20 percent; plus, the Senator also believes all Americans should allocate some of their income towards investments.

Setting aside MPS, one of the most effectively realistic savings plans consists of always keeping three months’ worth of living expenses in reserves; if a family needs at least $2,000 per month to cover rent or mortgage payments along with groceries, medicines, household items, utilities, and health insurance premiums, that family should strive to keep a cash reserve of $6,000.