Types of Propensities to Consume

The functional relationship between consumption and national income is known as Consumption Function. It represents the willingness of households to purchase goods and services at a given income level during a given period of time. It is represented as C = f(Y). The consumption function is a psychological concept that shows consumption levels at different income levels in an economy. Besides, it is influenced by subjective factors like consumer habits, preferences, etc. The two types of Propensities to Consume are Average Propensity to Consume (APC) and Marginal Propensity to Consume (MPC).

1. Average Propensity to Consume (APC):

It is the ratio of consumption expenditure to the corresponding income level. The formula to determine Average Propensity to Consume (APC) is:

Average~Propensity~to~Consume~(APC)=\frac{Consumption~(C)}{Income~(Y)}

Example:

Calculate APC and prepare a diagram for the same from the following schedule.

Income (Y)
(₹ Crores) Consumption (C)
(₹ Crores)
0 60
100 150
200 200
300 240
400 320

Solution:

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

From the above table, it can be seen that at ₹100 crores income level, APC = 1.5. It falls to 1 when the income increases to ₹200 crores. APC then falls to 0.8 and ultimately to 0.775 when the income levels are ₹300 crores and ₹400 crores, respectively.

In the above graph, income is shown on X-axis and consumption is shown on Y-axis. CC is the Consumption Curve and APC is any point on the consumption curve. For instance, at point A on the curve CC, $APC=\frac{ON}{OY_1}$

Income (Y) (₹ Crores)	Consumption (C) (₹ Crores)
0	60
100	150
200	200
300	240
400	320

Important facts about APC

1. APC is more than 1: As long as the consumption is more than the national income; i.e., if it is before the break-even point, the Average Propensity to Consume is greater than one. In the above case, APC is greater than one at 0 and ₹100 crores income level.

2. APC = 1: When consumption is equal to national income; i.e., at the break-even point, the Average Propensity to Consume is equal to one. In the above case, APC is equal to one at ₹200 crores income level.

3. APC is less than 1: When consumption is less than the national income; i.e., beyond the break-even point, the Average Propensity to Consume is less than one. In the above case, APC is less than one at ₹300 crores and ₹400 crores income level.

4. APC falls with an increase in income: As long as there is an increase in income, APC falls continuously because the level of income spent on consumption keeps on decreasing.

5. APC can never be zero: The only case possible for APC to be zero is when the consumption is zero, which is not possible, as consumption can never be zero at any income level. Even at zero income level, there is Autonomous Consumption $(\bar{c})$ .

2. Marginal Propensity to Consume (MPC):

It is the ratio of the change in consumption expenditure to the change in total income. In simple terms, MPC explains the proportion of change income that is spent on consumption. The formula to determine Marginal Propensity to Consume (MPC) is as follows:

Marginal~Propensity~to~Consume~(MPC)=\frac{Change~in~Consumption~(\Delta{C})}{Change~in~Income~(\Delta{Y})}

Example:

Calculate MPC and prepare a diagram for the same from the following schedule.

Income (Y)
(₹ Crores) Consumption (C)
(₹ Crores)
0 80
100 140
200 200
300 260
400 320

Solution:

$(\Delta{C})$

From the above table, it can be seen that when consumption increases from ₹80 crores to ₹140 crores with an increase in income from 0 to ₹100 crores, MPC = 0.6. Also, the value of MPC remains the same; i.e., 0.6 throughout the consumption function.

As the Marginal Propensity to Consume measures consumption curve’s slope, the constant value of the Marginal Propensity to Consume indicated that the consumption curve is a straight line.

In the above graph, the Marginal Propensity to Consume at point A with respect to point B = $\frac{\Delta{C}}{\Delta{Y}}=\frac{MN}{Y_1Y_2}$

Income (Y) (₹ Crores)	Consumption (C) (₹ Crores)
0	80
100	140
200	200
300	260
400	320

Important facts about MPC

1. Value of MPC varies between 0 and 1: As we know that the increment in income is either consumed or saved for future use. So, if the entire additional income is consumed; i.e., if $\Delta{S}=0$ , then MPC = 1. However, if the entire additional income is saved; i.e., if $\Delta{C}=0$ , then MPC = 0. In normal situations, MPC lies between 0 and 1.

2. MPC of the poor is more than the MPC of the rich: As the poor people spend a large proportion of their increased income on consumption because most of their basic needs remain unsatisfied, the MPC of the poor is more. However, as rich people already enjoy a high living standard, they spend a less proportion of their increased income on consumption; therefore, the MPC of the rich is less.

3. MPC falls with successive increases in income: As an economy becomes rich, it usually spends less percentage of its increased income, because of which MPC falls.

Difference between Average Propensity to Consume (APC) and Marginal Propensity to Consume (MPC)

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