Consumption Function: Relationship Between Marginal & Average Propensity to Consume

Consumption Function: Relationship Between Marginal & Average Propensity to Consume
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  • 0:05 Keynesian Consumption Function
  • 0:54 Average Propensity to Consume
  • 3:29 Marginal Propensity to Consume
  • 5:11 Graphing MPC
  • 5:58 MPC at the Household Level
  • 6:40 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
The United States economy is primarily driven by consumption. In this lesson, you'll learn about consumption, marginal propensity to consume, and average propensity to consume. A short quiz follows.

Keynesian Consumption Function

English economist John Maynard Keynes was one of the most influential economists of the 20th Century. Among many other things, he examined the propensity of people to consume. If we boil down how we use our after tax dollars, we pretty much buy stuff or save the income. Keynes argued that savings and consumption (that is, buying goods and services), are a function of income, and this has important implications for the economy in general as we will discuss shortly.

Two important factors we need to consider when analyzing the relationship between consumption and income is the average propensity to consume and the marginal propensity to consume. Let's look at each in turn.

Average Propensity to Consume

The average propensity to consume (APC) is the percentage of household income allocated towards purchasing goods and services, also known as consumption, rather than savings. You can calculate it with the following formula:

APC = C/Y

Where:

C = consumption

Y = income

So, if an economy has total household consumption of 1 trillion dollars and a total household income of 1.03 trillion, we can determine the average propensity to consume in that economy as follows:

APC = C/Y

APC = 1,00,000,000,000 / 1,030,000,000,000

APC = .97 or 97%

This average household in this economy allocates 97% of its income to consumption. The remaining 3% is allocated to savings.

Now, let's graph the following schedule of data to see what we can learn:

Y ( billions) C (billions)
200 200
300 290
400 385
500 480
600 575

The schedule compares the income, Y, of an economy to the same economy's consumption, or C. When income is $200 billion, consumption is also $200 billion. When income is $300 billion, consumption is equal to $290 billion. Income of $400 billion means there is consumption equaling $385 billion, and so on and so forth.

Now, let's see how this graphs out. When we graph the plot points, what we see is a straight line. This straight line is a graphical representation of this economy's average propensity to consume.

Average Propensity to Consume

You should note that as income increases, consumption increases, which is important. Why is it important? Simply, consumption is one way we can boost economic growth and prosperity because consumption requires businesses to make goods and services to sell and that requires them to purchase more raw materials, upgrade their facilities, and hire more people. This in turn creates more income for suppliers and employees who turn around and buy more stuff continuing the cycle.

Marginal Propensity to Consume

Another vital component of Keynes theory of consumption is marginal propensity to consume. The marginal propensity to consume is the change in consumption when income changes. It can be expressed with the following formula:

Marginal Propensity to Consume Formula

Where:

C = Change in consumption

Y = Change in income

The Delta sign means change.

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