Average Propensity to Consume

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.

Formula

Average propensity to consume is calculated by dividing total consumption C by total disposable income Y:

$$ \text{APC}\ =\ \frac{\text{C}}{\text{Y}} $$

If consumption C is defined as autonomous expenditure (c0) plus the product of marginal propensity to consume c1 and disposable income Y, we can write the formula for APC as follows:

$$ \text{APC}\ =\ \frac{\text{c} _ \text{0}+\text{c} _ \text{1}\times \text{Y}}{\text{Y}}=\frac{\text{c} _ \text{0}}{\text{Y}}+\text{c} _ \text{1} $$

The formula above shows that average propensity to consume equals autonomous expenditure divided by total income plus marginal propensity to consume. It makes another prediction too: average propensity to consume should fall if income Y increases. It is because a larger Y value causes c0/Y to fall which causes a decline in APC. This conclusion has important implications. It tells that if there is an increase in people’s income, they save more.

How APC differs from MPC?

Average propensity to consume differs from marginal propensity to consume in that the marginal propensity to consume represents the change in total consumption in response to change in total income while the average propensity to consume shows the cumulative measure of the relationship between consumption and income. MPC is the slope of the consumption function while APC is the slope of the straight-line connecting origin to the point on consumption function on which the APC is calculated.

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.

by Obaidullah Jan, ACA, CFA and last modified on

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