By: Hong-An Phan
The importance of saving, the MPC, and measuring the economy.
School is in session, meaning most students are learning how to balance their savings and spending. Between coffee chats, school lunches, and shopping dates, it is clear that spending money is much easier than saving it. Some students may be more experienced in this balanced practice, while others receiving their first few paychecks are still figuring out the perfect ratio.
Intuitively, most people can recognize that there are costs that must be put aside for necessities. Purchases used for food, housing, utilities, or gas are non-negotiable and must be preserved to function in day-to-day life. On the other hand, there are non-essential purchases such as a new bag or popular game that do not necessarily need to be bought to continue living a comfortable life.
This is when discretionary saving comes into play. Investopedia defines discretionary income as: “the amount of money that you have left for spending, investing, or saving after you've paid your taxes and paid for personal necessities, which include food, housing, and clothing—so-called non-discretionary expenses.” Saving these funds and using them instead for an emergency fund or investment is a strong financial strategy.
However, the key term here is ‘balance.’ While the objectively ‘correct’ course of action would be to save discretionary income, there should also be times to purchase items that have been properly budgeted for. For example, if there has been a separate saving put aside for a luxury item, and after a period of time this price has been met, then there is no need to avoid buying it.
In the larger scheme of macroeconomics, discretionary saving plays a role in a nation’s ability to spend money. This is referred to as the marginal propensity to consume (MPC) compared to the marginal propensity to save (MPS). These two metrics are used to measure the economy’s status. This means that whether or not the majority of the country has the means to be spending on items that are not considered ‘non-negotiable’ is proportionate to the economy’s strength.
The marginal propensity to consume is calculated by the change in consumption divided by the change in income. This formula was created by John Maynard Keynes during the Great Depression. According to Investopedia, “Keynes formally introduced the concept of marginal propensity to consume in his 1936 book The General Theory of Employment, Interest, and Money. Keynes argued that all new income must either be spent, as with consumption, or invested, as with savings.”
Photo by: Diane Helentjaris, Unsplash.
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