Average Propensity to Consume and Marginal Propensity to Consume

Average and Marginal Propensity to Consume

            The consumption function has two technical properties, i.e., average propensity to consume (APC) and marginal propensity to consume (MPC), which are separately discussed below:

1.   Average Propensity to Consume (APC):

            Average propensity to consume is the ratio of aggregate consumption expenditure to aggregate income. It is found by dividing consumption expenditure by income. Therefore, ratio of consumption to income is known as average propensity to consume. Thus, the relationship between gross national income and aggregate consumption expenditure is the average propensity to consume. Average Propensity to Consume is expressed as: APC = C/Y, where, C = Consumption expenditure and Y = Income level. APC shows the proportion or percentage of aggregate consumption to aggregate income. For example, when income is Rs. 100 crores and consumption expenditure is Rs. 60 crores. Then, APC = C/Y = = 0.6 or 60%. Thus, the value of APC for any income level may be found by dividing consumption expenditure by income.

            APC decreases as income increases because the proportion of income spent on consumption decreases. The remaining amount of total income after consumption expenditure is the saving. This can be calculated as follows:

Average propensity to save (APS) = 1–APC & APC = 1–APS

2.   Marginal propensity to consume (MPC):

            Marginal propensity to consume denotes the ratio of a small change in consumption as a result of a small change in income. In other words, it refers to the marginal increases in consumption (DC) as a result of marginal increases in income (DY) and is expressed as MPC = , where, D stands for small or marginal increase in consumption and income. Thus, marginal propensity to consume is obtained by dividing change in consumption by a change in income. MPC can also be obtained by subtracting MPS from 1, i.e., MPC = 1 – MPS, where, MPS = Marginal Propensity to save (MPS = 1– MPC).

            We can explain the concept of MPC with the help of a numerical example. Suppose, income increases from Rs. 100 crores to 120 crores, i.e., increment in income (DY) is Rs. 20 crores. Corresponding to this increase in income, consumption may increase from Rs. 60 crores to Rs. 70 crores, increment in consumption is Rs. 10 crores.

Hence, MPC = DC/DY or, MPC = 10/20 = 1/2 = 0.5 (less than unity)

            The complement of MPC is marginal propensity to save, MPS. It can be easily derived from MPC. We know that an increment in income DY will be divided between an increment in consumption DC and an increment in saving, DS. i.e.,

            DY = DC + DS

            Dividing both sides by DY, we get

            1 = +

or   MPC + MPS = 1

Therefore, MPS = 1 – MPC

            In the numerical case given above, MPC is or 0.5; therefore, MPS is (1 – ) = . Thus, if MPC is known, MPS can be easily known without any difficulty as the income of the community is divided between saving and consumption. If one is identified, the other can be easily derived.

            Marginal propensity to consume of people decreases as the aggregate income increases. Thus, MPC of poor people will be greater than the MPC to rich people. So, MPC will be greater than zero and less than one. I.e., MPC>0 and MPC<1 or, 0<MPC<1.

            Average propensity to consume and marginal propensity to consume can also be explained with held of table and diagram.

Average propensity to consume & marginal propensity to consume

(Rs in crores)

Disposable Income (Y)	Consumption (C)	APC =	MPC =
100	80	= 0.8	–
120	95	= 0.79	= 0.75
140	110	= 0.785	= 0.75
160	125	= 0.781	= 0.75
180	140	= 0.777	= 0.75
200	155	= 0.775	= 0.75
220	170	= 0.772	= 0.75

            In the above table, APC is decreasing with every increase in income, which indicates that as income increases, consumption also increases but a lesser rate, because some part of income is saved.

            Similarly, MPC is less than one but positive. It is because of increased whole income is not spent on consumption, a part of income is saved. In the table, with every change in income, consumption also changes. When the ratio of change in consumption and income is calculated in table which 0.75. It is positive but less than one.

            This feature of MPC is important aspect of Keynesian psychological law of consumption. Thus, it can be technically stated as 0<MPC<1.

Nature of APC and MPC both are explained in figure below;

            In the figure-(A), the average propensity to consume (APC) is measured at point P. The nature of consumption curve 'C' measures the value of APC, which is OC/OY. The flattering of the consumption curve (C) to the right shows every increase in income, APC declines.

            On the other hand, marginal propensity to consume (MPC) is measured by the slope of consumption curve (C). It is shown in figure-(B) by RS/PS, where RS is the change in consumption (DC) and PS is the change in income (DY) or C₁C₂/Y₁Y₂ = MPC.

            The concept of MPC is of utmost importance as it tells us how an increment in income will be divided between consumption and saving. In fact, the psychological law of consumption can be stated as that MPC is always less than one.