Propensity to consume represents the relationship between consumption expenditure and disposable income. This concept was introduced by British economist John Maynard Keynes in 1936. The study of consumption behavior plays a vital role in economics. It helps to determine the growth and development of the economy. Consumption is the beginning and as well as end of all economic activities. When a man wants something, then he makes an effort to get. So, he satisfies his want through consumption. When a person earns more he tends to consume more. The consumption pattern of a person shows the standard of his living. The propensity to consume has two technical properties which are explained below.
1. Average Propensity to Consume - APC
APC = C/Y
APC = Average Propensity to Consume
C = Consumption
Y = Income
Now suppose, if level of income of a nation is Rs. 200 billion while consumption spending is Rs. 140 billion, then propensity to consume of the nation can be calculated by dividing:
APC = C/Y
APC = 150/200
APC = 0.75
This indicates that the 75% of income is consumed while the remaining 25% is allocated for savings.
2. Marginal Propensity to Consume - MPC
MPC = CΔ
MPC = Marginal Propensity to Consume
C = Change in consumption
Y = Change in income
Now suppose, income rises from Rs. 100 billion to Rs. 110 billion and consumption rises from Rs. 80 billion to 90 billion. In this case, marginal propensity to consume will be:
MPC = CΔ
MPC = 10
MPC = 1
The table will be helpful to further understand these two concepts.
We can observe the above table that when the level of income is Rs. 200 billion the level consumption is Rs. 80 billion. When the income rises from Rs. 200 billion to Rs. 500 billion the consumption also rises from Rs. 80 billion to Rs. 300 billion. At this stage the value of APC is 0.60 and MPC is 0.73. When the level of income further rises from Rs. 500 billion to Rs. 800 billion the level of consumption also rises from Rs. 300 billion to Rs. 500 billion. As a result, the APC become 0.63 and MPC 0.67.
When the consumption level of people is high, more goods are produced that can boost the economy. On the other hand, when people tend to save more and consume less, fewer goods are produced which leads to fewer jobs and increased business closures.