Propensity to Consume:
Meaning and Definition of Propensity
The classical economists were of the view that the
supply of saving 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:
Propensity to Consume.
Propensity to Consume to Analyze the Consumption Function.
concepts are now explained in brief:
(1) Average Propensity to Consume
Average propensity to consume ( APC) may be defined as:
ratio of total consumption to total disposable income for different levels of
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 $2,000 billion, consumption expenditure is $1,500
billion, the average propensity to consumption is 1500/2000 = 0.75.
This shows that
out of the disposable income of $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 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
APC = C
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 0.62.
KL/OL = (C/Y) i.e., 2500/4000 or
25/40 = 0.62
APC implies a point on
the curve C which indicates the ratio of income consumed. The C curve is made up
of a series such points.
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
"As the relationship between a change in consumption (ΔC)
that resulted from a change in disposable income (ΔY)".
found out by dividing change in consumption to a given change in disposable
MPC = Change in Consumption = ΔC
Change in Income ΔY
Thus we make this concept clear by taking an example, let us
suppose the disposable income rises from $2000 billion to $3000 billion ( by
$1000 billion) and the consumption expenditure increases from $1500 billion to
$2000 billion (by $500 billion).
The marginal propensity to consume is:
ΔC/ΔY = 500/1000 = 1/2 = 0.5
All the concepts of consumption function are now
explained whit help of schedule and a diagram.
For Propensity to Consume:
Disposal Income (Y)
Consumption Expenditure (C)
Average Propensity to Consume (APC = C/Y)
Marginal Propensity to Consume (MPC = ΔC/ΔY)
800/1000 = 0.9
600/1000 = 0.6
500/1000 = 0.5
300/1000 = 0.3
200/1000 = 0.2
100/1000 = 0.1
reader can easily understand from the above schedule that with the increase in
the disposable income, the 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:
For Propensity to Consume:
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 450 helping line from O to ON. If we take any point on the 450 helping line,
income will be exactly equal to expenditure. The curve AG represents the income
consumption schedule, indicating the propensity to consumer at various levels of
income. Point A which is above 450 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 expenditures
exactly equal to disposable income and there is neither saving nor dis-saving.
This point is known is as break even point.
From B onward
up to G, the curve lies
below the 450 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 up to 450 helping line.
For example, when the income
is $5,000 billion, the expenditure is $3400 billion and saving $1,600
Marginal propensity to consume curve can also be
illustrated from the very same figure. At point B, income is $2,000 billion
and is equal to expenditure, i.e., $2,000. When income increases from
$2,000 billion to $3,000 billion, consumption increases only by $600
Now we move from point B towards right up by
$1,000 billion. BM line
shows as the increases in income. Then we go vertically until we reach point K.
MK line indicates addition made to the total consumption. It is equal to $600
billion. So the marginal propensity to consume will be equal to $600/$1000 = $6.