The average propensity to consume and the average propensity to save together equal

The average propensity to consume (APC) is a ratio that measures the portion of a household’s income that’s spent on goods and services rather than being saved.

Knowing the average propensity to consume is helpful for economists who monitor national spending patterns and behaviors. It can also be beneficial information for people who want to have a better understanding of where their money is going.  

Find out more about the average propensity to consume, its importance to a healthy economy, and what impact it can have on your savings.

The average propensity to consume (APC) measures what percentage of after-tax or disposable income a household uses to buy goods and services. This amount is the ratio of the total money spent over any given period of time to the disposable income earned during that time. 

Calculating the average propensity to consume is relatively straightforward:

Economists track the average propensity to consume as part of assessing the spending and saving habits of an entire country. However, individuals can also perform their own calculations to see what percentage of their income they spend rather than save. If your average propensity to consume is high, you may find yourself without much money left over after each paycheck—which means you might have trouble saving money toward your financial goals.

Some economists exclude housing-related expenses like rent and mortgage payments when calculating APC, while others include these costs. If you’re calculating your household’s APC, including the cost of housing may help you get the most accurate picture of how much money you spend.

Income can be either spent or saved. Every time you get paid, you have to decide how much of your income you’ll save and how much you’ll spend. There are lots of ways to set up your household budget to help you make these decisions. But to calculate your APC, you simply add up all your spending and divide it by your disposable income.

When calculating your household APC, remember to include any debt repayments in the “spend” category.

The average propensity to consume varies based on income levels. Households or individuals with higher incomes tend to have lower APCs, while households that earn less disposable income typically use a larger share to pay for essentials like food, housing, utilities and transportation.

For example, imagine two households both have yearly consumption of $40,000. Family A earns a disposable income of $46,000 per year, while Family B earns $82,000 per year in disposable income. When you calculate the average propensity to consume for both households, Family A’s APC equals 0.869 ($40,000/$46,000). That means family A spends nearly 87% of their disposable income, and their high APC leaves them only about 13% to save. However, Family B’s APC equals 0.487 ($40,000/$82,000), which means they spend less than 49% of their disposable income each year. 

There are two ways that you can decrease your APC. One is to increase your income while not increasing your spending, and the other is to find ways to decrease your spending. Either option will mean you spend a smaller percentage of your income, allowing you to dedicate more money toward your savings.

The opposite of the average propensity to consume is the average propensity to save. The two work hand-in-hand—if you’re doing more of one, you’re doing less of the other. The average propensity to save (APS) is the ratio of savings to disposable income. To calculate your average propensity to save:

The average propensity to consume and the average propensity to save always have a sum equal to one. The portion of your disposable income you spend and the portion you save add up to your total income.

Tracking the average propensity to consume on the national level is one way economists assess the economy's overall health.

When consumers spend money, it stimulates the economy. More demand for goods and services means sales increase, businesses make money, and more workers can be employed. The opposite is also true. When the national APC decreases, it means consumers are spending less—which could harm the economy due to businesses losing profits, closing down, and therefore employing fewer workers.

But considering your household’s APC is much simpler: the more disposable income you spend, the higher your APC. Conversely, the more income you put into savings, the lower your APC. It’s important to have a good understanding of your financial goals to make the best money decisions for yourself and your family. The key is to strike the right balance between your spending needs and your savings goals. 

• Income is either spent or saved. The portion of after-tax income that is spent is the average propensity to consume.
• An increase in the average propensity to consume means a decrease in the average propensity to save.
• The average propensity to consume is a measure mainly used by economists, but people can also apply it to their own household income and spending.

Understanding Average Propensity to Consume

In the economic sense, a high average consumer expenditure can be a good indicator. Household-related spending is the economic mainstay that plays a significant role in keeping the economy alive.

High household spending creates a demand for goods and services that keep businesses profitable and facilitates the hiring of more workers. Conversely, a lower average propensity to consume can be detrimental to the economy.

A high rate of saving causes the demand for products and services to fall, which, in turn, causes business closures and, eventually, job losses. Generally, a higher propensity to consume is associated with low-income households.,

The fact is explained by the hypothesis that low-income households often engage in dissaving. They frequently either run down their disposable income on necessities or borrow against their future income.

In contrast, middle-income households exhibit a low average propensity to consume, given that they are either saving for old age or paying back previous debts. Economic experts closely monitor middle-income households. They demonstrate confidence in their financial health, given their spending and saving patterns.

It is important to note that the average propensity to consume varies inversely with income over time, given that actual labor income will rise and fall along with the long-run average.

The average propensity to consume is closely related to the marginal propensity to consume. However, the marginal propensity to consume slightly differs from the former in that it represents the change in total consumption in response to a change in total household income.

Graphically, the average propensity to consume is represented by the slope of the straight line that connects the point of consumption function to the point of origin.  The marginal propensity to consume, on the other hand, is represented by the slope of the consumption function.

Average Propensity to Save vs. Average Propensity to Consume

In the economy, the sum of these two metrics is always equal to one. This equality is based on the fact that a household must either save or spend all its disposable income.

Put another way, the average propensity to save is the inverse of the average propensity to consume. The saving ratio is based on the percentage of the disposable household income that is saved.

To determine a realistic measure, the personal propensity to consume is determined by using the disposable income figure. The current population’s saving rate can be associated with factors such as the age composition of a country’s population and future saving plan behavior.

For example, variation in age composition defines the national saving rate, given that during peak earnings of a birth cohort, there is a relatively higher saving rate, and during low incomes, the saving rate is relatively low.

The National Average Saving Propensity

Economists are interested in estimating a national average propensity to consume because it indicates the proportion of household income that is consumed, as well as the amount saved.

Finding out where the current disposable income is utilized is important. It can be explained by the idea that the saving rate is the driver of the economy, while the consumption rate determines the APC component of the Gross Domestic Product (GDP). The average propensity to consume is calculated using the following formula:

Example

Consider a household with a total consumption of $40,000 out of a total income of $70,000. An individual’s propensity to consume is calculated as follows:

Average Propensity to Consume =  $40,000 / $70,000 = 0.571

Although the average propensity can explain the past consumption pattern of a household, finding out how consumption is affected by any increase in income is determined using the marginal propensity to consume. It makes the average marginal propensity to consume a comparatively more robust measure of consumption.

Assume a hypothetical disposable income of a country is equal to its GDP of $200 billion for the previous year. Savings for the economy totaled $150 billion in the same year, and the rest catered for goods and services.  From the given values, a country’s average propensity to save is $150 billion divided by $200 billion, which is equal to 0.75. It implies that the nation’s proportion of disposable income that is saved is 0.75.

More Resources

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