What is the average propensity to consume?

Average propensity to consume (APC) considers the average amount of money spent out of the income earned. The average propensity to consume can impact economic development, and it indicates the state of the economy.

When economic entities have higher income, they tend to increase their consumption by buying not only necessary goods and services but also luxury ones, augmenting the overall spending level in the economy. APC depends on the level of income. The increased APC suggests that businesses will increase their profitability since they will sell more goods and services.

Average propensity to consume explained

Calculating average propensity to consume is straightforward because it considers the money spent as a portion of the money earned:

APC = Amount consumed / Income

In terms of consumption of basic necessities, it is generally accepted that the APC for lower-income households and individuals is higher compared to high-income households.

Let's say that the amount of money needed for basic necessities is $2,500. Household A’s income is $25,000, while household B has an income of $100,000. Hence, APC for household A is 10 per cent (2500/25000) and it is 2.5 per cent for household B (2,500 / 100,000). It is evident that the APC for low-income households is much higher.

Factors affecting average propensity to consume

Multiple factors can increase or decrease the consumption expenditure of households. Some of them are:

Income level. It denotes the total amount of money earned through employment or investments. Income has a major effect on consumption in a given economy. In general, the higher the income, the higher the consumption, and vice versa.

Changes in interest rates. They have a positive or negative effect on the consumption level. If there is a substantial increase in interest rates, households may decide to save their money for the purpose of earning a higher interest rate. This decision will decrease the level of consumption.

Future expectations about income levels, emergencies, the money needed for the purchase of capital goods, inflation. When households expect a decrease in future income, that may increase their current savings so they could smooth consumption in the future.

Changes in taxation. When taxes are increased, households have less money to cover expenditures. Consequently, the consumption level is decreased. The opposite happens when taxes are decreased. Households have more money at their disposal so they could decide to increase their consumption.