Average Propensity To Consume (APC) Meaning & Example

What Is Average Propensity To Consume?

Average propensity to consume (APC) measures the percentage of income that is spent rather than saved. This may be calculated by a single individual who wants to know where the money is going or by an economist who wants to track the spending and saving habits of an entire nation.

In either case, the propensity to consume can be determined by dividing average household consumption, or spending, by average household income, or earnings.

Understanding Average Propensity To Consume

From the broader economic view, a high average propensity to consume is generally good for the economy. When the average propensity to consume is high, consumers are saving less and spending more on goods or services. This increased demand drives economic growth, business expansion, and broad employment.

Low-income households are often seen as having a higher average propensity to consume than high-income households. Low-income households may be forced to spend their entire income on necessities with minimal disposable income remaining to save. Alternatively, high-income households with higher cash flow after their necessities are met typically have a relatively lower average propensity to consume.

Economists often gauge economy forecasts on actions by the middle-income households. The spending and savings patterns of this demographic often indicate a degree of confidence or pessimism about their own personal financial situations and the economy as a whole.

Propensity To Consume vs. Propensity To Save

The sum of the average propensity to consume and the average propensity to save is always equivalent to one. A household or a nation must either spend or save all of its income.

The inverse of the average propensity to consume is the average propensity to save (APS). That figure is simply total savings divided by income. The result is known as the savings ratio.

Notably, the savings ratio is normally based on its percentage of disposable income, or after-tax income. An individual determining personal propensities to consume and save should probably use the disposable income figure as well for a more realistic measure.

Example of Average Propensity To Consume

Assume a nation's economy has a gross domestic product (GDP) equivalent to its disposable income of $500 billion for the previous year. The total savings of the economy was $300 billion, and the rest was spent on goods and services.

The nation's APS is calculated to be 0.60, or $300 billion/$500 billion. This indicates the economy allocated 60% of its disposable income to savings. The average propensity to consume is calculated to be 0.40, or (1 - 0.60). Therefore, the nation spent 40% of its GDP on goods and services.

APS can include saving for retirement, a home purchase, and other long-term investments. As such, it can be a proxy for national financial health.

Special Considerations

The marginal propensity to consume (MPC) is a related concept. It measures the change in the average propensity to consume.

Assume that the nation in the previous example increased its GDP to $700 billion and its consumption of goods and services rose to $375 billion. The economy's average propensity to consume increased to 53.57%.

The nation's consumption increased from $200 billion to $375 billion. Alternatively, the nation's GDP increased from $500 billion to $700 billion. The nation's marginal propensity to consume is 87.5% ($375 billion - $200 billion) / ($700 billion - $500 billion). The marginal propensity measures the directional trend of how an entity is utilizing its money. In this case, 87.5% of new growth was further consumed.