Marginal propensity to consume (MPC) & Average APC

The classical economists were of the view that the supply of savings was determined by the rate of interest prevailing in the country. According to them, the higher the rate of interest, the larger is the saving and so less is the consumption. Keynes disagreed with the above view. According to him, interest is not the primary determinant of an individual’s saving and consumption decisions. It is primarily the individual’s real income which determines his, saving and consumption decisions. J. M. Keynes has developed two concepts

  1. Average propensity to consume
  2. Marginal propensity to consume (marginal propensity to spend) to analyze the consumption function.

These two concepts are now explained in brief.

(i) Average Propensity to Consume

Average propensity to consume (APC) may be defined as the ratio of total consumption to total disposable income. It is calculated by dividing the amount of consumption by disposable income for any given level of income. For instance, when nation’s disposable income is Rs. 2,000 billion, consumption expenditure is Rs, 1,500 billion, the average propensity to consume is 1500/2000 = 0.75. This shows that out of the disposable income of Rs. 2,000 billion, 75% will be used for consumption purposes. The APC declines as income increases because the proportion of income spent on consumption decreases. The average propensity to consume at any level of income is expressed in equation as C/Y. Here C stands for consumption Y for income.

Symbolically; APC = v

propensity to consume fig 30.2

In the Fig. (30.2) income is plotted on OX axis and consumption along OY. CC curve represents the propensity to consume schedule. At point K, the average propensity to

consume is equal to .62

KL _ (C2500                              25

–        i.e.‘ 4000 or .40 = .62

APC implies a point on the curve C which indicates the ratio of total consumption to total income. The C curve is made up of a series of such points.

(ii) Marginal Propensity to Consume .(MPC)

The concept of marginal propensity to consume is very important is macro economics, J.M. Keynes has defined marginal propensity to consume (MPC) “as the relationship between a change in consumption (AC) that resulted from a change in disposable income (AY). It is found out by dividing change in consumption to a given

change in disposable Income. Thus

Change in consumption       Ac

.MPC –           Change in income .       Ay

We make this concept clear by taking an example, let us suppose the disposable national income rises from Rs. 2,000 billion to Rs. 3,000 billion (by Rs. 1,000 billion) and the consumption expenditure increases from Rs. 1,500 billion to Rs.2,000 billion (by Rs. 500

billion). The marginal propensity to consume is

Ac         500           1

MPC –         –

Ay         1000 – 2 –

All the three concepts of consumption function are now explained with help schedule and a diagram.

Consumption Schedule

National Disposal income Y Consumption Expenditure

Average Propensity
to consume
(APC) = C/y

 

Marginal Propensity
to, consume
(MPC) = Ac/Ay

 

A 1,000 1,100 1100/1000 = 1.1 900/1000 = .9
B 2,000 2,000 2000/2000 = 1.0 600/1000 = 6
C 3,000 2,600 2600/3000= • .86 500/1000 = .5
D 4,000 3,100 3100/4000 = .77 300/1000 = 3
E 5,000 3,400 3400/5000 = .68 200/1000 = 2
F 6,000 3,600 3600/6000 = .6 100/1000 = 1
G 7,000 3,700     , 3700/7000 = .53

The reader can easily understand from the above schedule that with the increase in the disposable income, the propensity to consume and the marginal propensity to, consume decreases and conversely with a fall in income, the propensity to consume and the marginal propensity to consume increases. The consumption schedule can also be explained with the help of a curve which is given below:-

Y Propensity to Consume Curve Fig. 30.3 1

In the figure (30.3), disposable income is

measured, along the horizontal axis OX and

consumption along the vertical axis OY. Let us now draw a 45° helping line from 0 to ON.

The curve AG represents the income consumption schedule, indicating the propensity to consumer at various levels of income. Point A which is above 45° helping line, shows us that the expenditure is greater than its income. This deficit in income can be converted either by borrowing or from the sale of assets. At point B, consumption expenditure is exactly equal to disposable income and there is neither saving nor dis-saving. This point is known as break even point. From B onward upto G, the curve lies below the 45° helping line. This shows that the consumption expenditure is less than the disposable income. Net saving is measured by the distance from the propensity to consume curve upto 45° helping line. For example, when the income is…Rs. 5,000 billion, the expenditure is Rs. 3400 billion and Saving Rs. 1,600 billion. •

Marginal propensity to consume curve can also be illustrated from the very same figure. At point B, income is Rs. 2,000 billion and is equal to expenditure, i.e., Rs. 2,000 billion. When income increases from Rs. 2,000 billion to Rs. 3,000 billion, consumption increases only by Rs. 600 billion. Now we move from point B towards right up by Rs. 1,000 -billion. BM line shows us the increase in income. Then we go vertically until we reach point K. MK line indicates addition ‘made to the total consumption. It is equal to Rs. 600 billion. So the marginal propensity to consume will be equal to Rs. 600/1000 = .6.

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