Average Propensity to Consume

What is the Average Propensity to Consume?

Definition: Average propensity to consume (APC) is the percentage of total disposable income which households spend on goods and services. It is the ratio of total consumption to total disposable income.

Economists are interested in estimating the average propensity to consume because it tells them what proportion of their income households consume and how much they save. Since consumption rate determines the personal consumption expenditure component of the GDP and savings rate is the driver of private investments and eventually future growth in consumption, finding out where current income is utilized is important.

The average propensity to consume (APC) expresses the percentage of income consumed at any given level of income. In other words, it’s the amount of income the average consumer spends on goods and services.

The basic assumptions are:

  1. Price level stability;
  2. Self-sufficient economy;
  3. No undistributed profits;
  4. No state sector.

The total consumption depends on the total income and there is a positive correlation between the two.

What Does Average Propensity to Consume Mean?

During periods of robust economic activity, the average propensity to consume is higher because consumer spending is strengthened. Consumers are spending more money based on their household income, and businesses realize a higher profit, thereby boosting employment. In fact, countries with a high APC have lower unemployment rates due to the increased demand that creates additional jobs.

The average propensity to consume (APC) indicates what the household sector does with income. The APC indicates the portion of income that is used for consumption expenditures. If, for example, the APC is 0.9, then 90 percent of income goes for consumption.

The standard formula for calculating average propensity to consume (APC) is:

APC = Consumption / Income

The concept of propensity to consume (i.e., willingness to consume) or the so-called consumption function is based on a ‘funda­mental psychological law’ which states that “men are disposed, as a rule, and on an average, to increase consumption as their income increases but not by as much as the increase in their income.”

Although many factors influence aggregate consumption, aggregate disposable income or national income is, by far, the most important one in the Keynesian theory. So, here we will concentrate on the relationship between planned consumption and income — the consumption function.

Example

Let’s work out average propensity to consume in the following cases: (a) Mark’s total consumption is $60,000 out of total income of $100,000; (b) Jerry has autonomous expenditure of $10,000, his marginal propensity to consume is 0.6 and his disposable income is $80,000.

APC in case of Mark is straightforward, we just need to divide $60,000 by $100,000 to get 0.6.

In case of Jerry, APC equals $10,000/$80,000 plus 0.6, which equals 0.725.

It shows that Jerry consumes a higher proportion of his income on average as compared to Mark because he has higher APC. Even though APC can tell us about past consumption pattern of both Jerry and Mark, if we are interested in finding out how any increase in income will change consumption, we must turn to the marginal propensity to consume. It is why MPC is a more popular measure of consumption than APC.

Understanding Average Propensity To Consume

From the broader economic view, a high average propensity to consume can be a good thing. Consumer spending drives the economy. High demand for goods and services keeps more people employed and more businesses open.

In general, low-income households are seen as having a higher average propensity to consume than high-income households. This is reasonable enough, as low-income households may be forced to spend their entire disposable incomes on necessities.

It is the middle-income households that bear close watching. Their spending and saving patterns indicate a degree of confidence or pessimism about their own personal financial situations and the economy as a whole.

What You Need to Know about Average Propensity to Consume

It’s expressed as a percentage, showing the proportion of disposable income, or income after tax, which is spent on consumer goods. It usually varies with levels of income. Households with a higher income tend to have a lower average propensity to consume. This is because they need to spend less of their cash on basic goods and services. Any change in the average propensity to consume is measured by marginal propensity to consume.

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