What is the Average Propensity to Consume?

//What is the Average Propensity to Consume?
What is the Average Propensity to Consume? 2017-09-30T06:46:55+00:00

Definition: 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 and (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.

Let’s look at an example.

Example

The average propensity to consume formula is calculated by dividing total consumption (what is spent on goods and services) by total income (what is earned) in a given period. Therefore, the equation for APC is:

APC = Consumption / Income.

John and Mary are concerned with their spending habits. They believe that they are spending more than they earn on a monthly basis. Therefore, they decide to calculate the average propensity to consume for different levels of income ranging from $2,000 to $12,000 and take appropriate measures.

To that end, they create a consumption table as follows:

Income Consumption APC
$0 $2,000 0.00
$2,000 $1,500 0.75
$4,000 $2,850 0.71
$6,000 $4,000 0.67
$8,000 $5,200 0.65
$10,000 $6,200 0.62
$12,000 $7,100 0.59

Once they divide consumption by the income, they derive a different APC per different level of income. As their income rises from $2,000 to $12,000, the APC decreases from 0.75 to 0.59, respectively. Therefore, although the growth rate of income is higher than the growth rate of consumption, as the income increases, the percentage of consumption decreases.

This makes sense because as consumers earn more money, their living expenses become a smaller percentage of their total income. Also, they typically begin to save more of it and spend a smaller percentage of it.