Posted on

Propensity to Consume

The propensity to consume shows the changes in consumption brought about as a result of changes in income. It is an “if…then” concept. That is, if income increases then what will happen to consumption etc., or what proportion of it will be spent on consumer goods?

Average Propensity to Consume (APC):
This is that portion of the total income that is spent on the consumption of goods and services. To calculate the APC, the total expenditure on consumer goods and services is divided by the total income earned. This is given as:
APC = C/Y
where
APC = Average Propensity to Consume
C = Total Expenditure on Consumption
Y = Total Income

Average Propensity to Save (APS):
This is that portion of the total income that is not spent on the consumption of goods and services. To calculate the APS, the total savings are divided by the total income earned.
APS = S/Y
where
APS = Average Propensity to Save
S = Savings
Y = Total Income

The higher the income, the higher the propensity to save and the lower the propensity to consume. Example: If the national income was ₦20 billion and total consumer spending was ₦16 billion, this means that out of every ₦20 received as income, ₦16 is spent on consumer goods. The average propensity to consume (APC) would be:
APC = 16/20 = 4/5ths

The average propensity to save (APS) would be:
APS = S/Y
S = Saving, Y = Income, APS = Average Propensity to Save
APS = 4/20 = I/5th. This means that out of every ₦5 received as income, ₦1 would be saved.

Note: APC+APS =1, APC = 1 -APS, APS = 1 – APC

Marginal Propensity to Consume (MPC): the MPC measures that fraction of an income that would be spent on the consumption of consumer goods as a result of a slight increase in income. It is given as:
MPC = ΔC/ΔY
Where
MPC = Marginal Propensity to Consume
ΔC = Change in Consumption
ΔY = Change in income

Marginal Propensity to Save (MPS): This measures the proportion of income that is saved as a result of a slight increase in income. It is given as:

MPS = ΔS/ΔY

Example:
If National Income (NI) increases by ₦8 billion and consumption (C) increases by ₦6 billion, then MPC would be 6/8 this = 3/4ths. Therefore the marginal propensity to save (MPS) would be 2/8ths = 1/4th. So if 3/4 of the increase is spent on consumption, then the other 1/4th must be saved.
Note: MPS = ΔS/ΔY
where

MPS = Marginal Propensity to Save
ΔS = Change in Savings
ΔY = Change in Income
and
MPC+ MPS = 1
MPC+ 1- MPS
MPS= 1 -MPC

Examples on APC and MPC

Example 1 on APC
If Mr. B’s monthly income is ₦18,000 and he spends ₦12.000, on consumer goods and services, what will be his average propensity to consume and save?

Solution 1
Total income = Y =₦18,000
Consumption = C = ₦12,000
APC = C/Y =12,000 = 12/3 = 0.67 or 67% = 67%
Since APC + APS =1, APC = 1-APC
.’. APS=1-0.67=0.33 or 33%

Example 2
If the monthly income of an individual rises from 86,000 to 89,000 and his consumption level rises by NI,000, calculate his marginal propensity to consume and to save.

Solution 2
Original Monthly Income = ₦6,000
New Monthly Income = ₦9,000
Change in Income(ΔY) = (9,000-6,000) = 43,000
Change in Consumption (ΔC) = 41,000
MPC=1,000/3,000 = 0.33 = 33%
MPC+ MPS = 1
MPS=1 – MPC
MPS = 1 – 0.33 = 0.67 = 67%

READ MORE