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What is Propensity to Consume?
Propensity to consume is an economic concept that measures the proportion of income that individuals or households spend on consumption rather than saving.
Definition
Propensity to consume refers to the relationship between income levels and consumer spending, indicating how much income is used for consumption.
Key Takeaways
- Shows how income changes affect consumer spending.
- Central to Keynesian economic theory.
- Influences economic growth and fiscal policy effectiveness.
Understanding Propensity to Consume
The propensity to consume helps economists understand spending behavior as income rises or falls. It reflects consumer confidence, income stability, and expectations about the future.
People with lower incomes typically have a higher propensity to consume because they spend a larger share of income on necessities. Higher-income individuals often save a greater portion of additional income.
This concept is crucial in analyzing the effectiveness of tax cuts, stimulus payments, and government spending programs.
Types of Propensity to Consume
Average Propensity to Consume (APC): Total consumption divided by total income.
Marginal Propensity to Consume (MPC): Change in consumption resulting from a change in income.
Formula (If Applicable)
Average Propensity to Consume:
APC = Total Consumption / Total Income
Marginal Propensity to Consume:
MPC = Change in Consumption / Change in Income
Real-World Example
If a household earns $5,000 per month and spends $4,000, its average propensity to consume is 0.8. If income increases by $1,000 and spending rises by $700, the marginal propensity to consume is 0.7.
Importance in Business or Economics
Propensity to consume influences aggregate demand, economic growth, and inflation. Policymakers use it to design fiscal stimulus, while businesses use it to forecast consumer demand and revenue sensitivity.
Related Terms
- Aggregate Demand
- Savings Rate
- Keynesian Economics
Sources and Further Reading
- Investopedia — Propensity to Consume
- Khan Academy — Consumption and Income
- IMF — Macroeconomic Policy
Quick Reference
- Measures income spent on consumption.
- Key input for fiscal policy analysis.
- Varies across income levels.
Frequently Asked Questions (FAQs)
What is the difference between APC and MPC?
APC measures total spending relative to income, while MPC measures spending changes from income changes.
Why is marginal propensity to consume important?
It determines the size of the multiplier effect in the economy.
Does propensity to consume differ by income group?
Yes. Lower-income households usually have higher propensities to consume.
