What is the Average propensity to consume’
The average propensity to consume (APC) refers to the percentage of income spent on the purchase of goods and services rather than on savings. One can determine the percentage of income spent by dividing the average household consumption, or spending, on average household income, or that earned. The inverse of the average propensity to consume average propensity to save (APS).
Breaking down the ‘Average propensity to consume’
Economic times when consumers are unable to stimulate the economy. Purchased more goods, the demand for goods and services, as well as an increase in the number of people employed and more businesses open. The periods when the desire to save is increase can have a negative effect on the economy, as people buy fewer goods and services; low demand for goods and services, which leads to a decrease in the number of jobs and increased business closures.
Low-income households are believed to have a higher average propensity to consume than high-income. Families with low incomes, tend to spend more of their disposable income on necessities than high-income that causes the high percentage of income spent on the purchase of goods and services.
The difference between the average propensity to consumption and average propensity
The sum of average propensity to consume and average propensity to save is equal to 1, since households allocate income to savings and consumption. Contrary to the average propensity to consume, the APS is calculated as a percentage of total income used for savings, not expenditures on goods and services. The average propensity to consume can also be calculated by subtracting the MTA from 1 year.
For example, suppose that the economy’s gross domestic product (GDP) equivalent to its net income of $500 billion for the previous year. Total saving of the economy 300 billion dollars, and the rest was spent on the purchase of goods and services. Consequently, the APS is calculated 0.60, or $300 million/ $ 500 million. This indicates that the economy spent 60% of their income for savings. Conversely, the average propensity to consume is calculated 0.40, or (1 – 0.60). Thus, the economy spent 40% of its GDP on goods and services.
The marginal propensity to consume
The marginal propensity to consume (MPC) is a key concept and reflects the change in the average propensity to consume. Suppose in the previous example, the economy increased its GDP by $ 700 billion, and consumption of goods and services increased to $ 375 billion. The average tendency of the economy to the consumption increased to 53.57%, while the marginal propensity to consume was 87.50%; therefore, 87.50% of additional GDP, or of disposable income was spent on goods and services.