What is Propensity to Save?

S7-SA7-0129

Grade Level:

Class 12

AI/ML, Physics, Biotechnology, FinTech, EVs, Space Technology, Climate Science, Blockchain, Medicine, Engineering, Law, Economics

Definition

What is it?

Propensity to Save (also called Marginal Propensity to Save or MPS) measures how much of an extra rupee of income a person or household saves, instead of spending. It tells us the proportion of additional income that is put aside for future use. For example, if you get 100 rupees extra, and save 20 rupees, your MPS is 0.2.

Simple Example

Quick Example

Imagine your aunt gives you an extra ₹500 for doing well in your exams. If you decide to put ₹150 into your piggy bank and spend the remaining ₹350 on a new cricket ball, your propensity to save from that extra ₹500 is the saved amount (₹150) divided by the extra income (₹500).

Worked Example

Step-by-Step

Let's say a family's income increases from ₹30,000 per month to ₹35,000 per month. Their savings also increase from ₹5,000 to ₹6,500 per month.
1. First, find the change in income: New Income - Old Income = ₹35,000 - ₹30,000 = ₹5,000.
---2. Next, find the change in savings: New Savings - Old Savings = ₹6,500 - ₹5,000 = ₹1,500.
---3. Now, calculate the Propensity to Save (MPS) using the formula: MPS = Change in Savings / Change in Income.
---4. MPS = ₹1,500 / ₹5,000.
---5. MPS = 0.3.
So, the family's Propensity to Save is 0.3. This means for every extra rupee they earn, they save 30 paise.

Why It Matters

Understanding Propensity to Save helps economists predict how people will react to income changes, which is crucial for government policies and business planning. In FinTech, it's used to design personalized savings plans. Even in AI/ML, models predict consumer behavior, and MPS is a key input, helping create better financial products and services.

Common Mistakes

MISTAKE: Confusing Propensity to Save with total savings. | CORRECTION: Propensity to Save is about the *change* in savings from *change* in income, not the total amount saved.

MISTAKE: Calculating MPS using total income and total savings. | CORRECTION: Always use the *change* in income and the *change* in savings. The formula is Delta S / Delta Y (where Delta means change).

MISTAKE: Expressing MPS as a percentage without converting. | CORRECTION: MPS is usually a ratio or decimal between 0 and 1. If you want to express it as a percentage, multiply the decimal by 100 after calculating it.

Practice Questions

Try It Yourself

QUESTION: If your pocket money increases by ₹200 and you save ₹80 of that extra money, what is your Propensity to Save? | ANSWER: 0.4

QUESTION: A small shop owner's monthly profit increased by ₹10,000. If their monthly savings increased by ₹3,500, what is their Propensity to Save? | ANSWER: 0.35

QUESTION: An individual's income rises from ₹40,000 to ₹48,000. Initially, they saved ₹6,000. After the income rise, they saved ₹8,400. Calculate their Propensity to Save. | ANSWER: 0.3

MCQ

Quick Quiz

What does a Propensity to Save of 0.6 mean?

For every ₹100 earned, ₹6 is saved.

For every extra ₹100 earned, ₹60 is saved.

Total savings are 60% of total income.

Spending is 60% of extra income.

The Correct Answer Is:

Propensity to Save (MPS) is the proportion of *additional* income that is saved. So, an MPS of 0.6 means that for every extra rupee earned, 60 paise (or ₹60 for every ₹100) is saved.

Real World Connection

In the Real World

Banks and financial institutions in India use the concept of Propensity to Save when designing savings accounts or investment plans. For example, if a bank observes that young professionals in Tier 2 cities have a high MPS from their bonus income, they might create specific 'bonus saver' schemes with attractive interest rates to encourage them to save more.

Key Vocabulary

Key Terms

INCOME: Money received, especially on a regular basis, for work or through investments. | SAVINGS: Money set aside for future use. | PROPORTION: A part, share, or number considered in comparative relation to a whole. | MARGINAL: Referring to the change in an economic variable that results from a one-unit increase in some other variable.

What's Next

What to Learn Next

Now that you understand Propensity to Save, you should explore 'Propensity to Consume'. These two concepts are closely related and together explain how people allocate their income between spending and saving, which is fundamental to understanding macroeconomics!