What is the Average Propensity to Consume (APC)?
The average propensity to consume (APC) is a measure of the fraction of the total disposable income consumed. It is considered a significant concept for both individual consumers and economists.
The APC can be used by an individual to determine where their income is being utilized, while an economist can use it to monitor spending and saving behavior of an entire nation.
Low-income families are said to demonstrate a higher propensity to consume compared to high-income earners. Either way, the ratio is determined by dividing the total household consumption by the total household disposable income.
- The average propensity to consume (APC) is the cumulative measure of the fraction of spent income.
- The APC is graphically represented by the slope of the consumption function.
- An estimate of the average propensity to consume not only shows the proportion of household income that is saved but also the total amount saved.
Understanding Average Propensity to Consume
In the economic sense, a high average consumer expenditure can be a good indicator. Household-related spending is the economic mainstay that plays a significant role in keeping the economy alive.
High household spending creates a demand for goods and services that keep businesses profitable and facilitates the hiring of more workers. Conversely, a lower average propensity to consume can be detrimental to the economy.
A high rate of saving causes the demand for products and services to fall, which, in turn, causes business closures and, eventually, job losses. Generally, a higher propensity to consume is associated with low-income households.,
The fact is explained by the hypothesis that low-income households often engage in dissaving. They frequently either run down their disposable income on necessities or borrow against their future income.
In contrast, middle-income households exhibit a low average propensity to consume, given that they are either saving for old age or paying back previous debts. Economic experts closely monitor middle-income households. They demonstrate confidence in their financial health, given their spending and saving patterns.
It is important to note that the average propensity to consume varies inversely with income over time, given that actual labor income will rise and fall along with the long-run average.
The average propensity to consume is closely related to the marginal propensity to consume. However, the marginal propensity to consume slightly differs from the former in that it represents the change in total consumption in response to a change in total household income.
Graphically, the average propensity to consume is represented by the slope of the straight line that connects the point of consumption function to the point of origin. The marginal propensity to consume, on the other hand, is represented by the slope of the consumption function.
Average Propensity to Save vs. Average Propensity to Consume
In the economy, the sum of these two metrics is always equal to one. This equality is based on the fact that a household must either save or spend all its disposable income.
Put another way, the average propensity to save is the inverse of the average propensity to consume. The saving ratio is based on the percentage of the disposable household income that is saved.
To determine a realistic measure, the personal propensity to consume is determined by using the disposable income figure. The current population’s saving rate can be associated with factors such as the age composition of a country’s population and future saving plan behavior.
For example, variation in age composition defines the national saving rate, given that during peak earnings of a birth cohort, there is a relatively higher saving rate, and during low incomes, the saving rate is relatively low.
The National Average Saving Propensity
Economists are interested in estimating a national average propensity to consume because it indicates the proportion of household income that is consumed, as well as the amount saved.
Finding out where the current disposable income is utilized is important. It can be explained by the idea that the saving rate is the driver of the economy, while the consumption rate determines the APC component of the Gross Domestic Product (GDP). The average propensity to consume is calculated using the following formula:
Consider a household with a total consumption of $40,000 out of a total income of $70,000. An individual’s propensity to consume is calculated as follows:
Average Propensity to Consume = $40,000 / $70,000 = 0.571
Although the average propensity can explain the past consumption pattern of a household, finding out how consumption is affected by any increase in income is determined using the marginal propensity to consume. It makes the average marginal propensity to consume a comparatively more robust measure of consumption.
Assume a hypothetical disposable income of a country is equal to its GDP of $200 billion for the previous year. Savings for the economy totaled $150 billion in the same year, and the rest catered for goods and services. From the given values, a country’s average propensity to save is $150 billion divided by $200 billion, which is equal to 0.75. It implies that the nation’s proportion of disposable income that is saved is 0.75.
CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: