Question

What do understand by Average Propensity to Consume and Marginal Propensity to Consume ? Establish the relationship between these two with the help of an example and diagram.

Hint:

Remember the core difference: APC relates total consumption to total income (\(C/Y\)), while MPC relates a change in consumption to a change in income (\(\Delta C / \Delta Y\)). A schedule is often the clearest way to demonstrate that as income rises, APC falls, and that APC is generally greater than MPC.

Answer 1

The Average Propensity to Consume is the ratio of total consumption expenditure (C) to total disposable income (Y). It represents the proportion of income that is spent on consumption.

\[ \text{APC} = \frac{\text{Consumption} (C)}{\text{Income} (Y)} \]

Marginal Propensity to Consume (MPC):

The Marginal Propensity to Consume is the ratio of the change in consumption expenditure (\(\Delta C\)) to the change in disposable income (\(\Delta Y\)). It represents the proportion of an additional unit of income that is consumed.

\[ \text{MPC} = \frac{\text{Change in Consumption} (\Delta C)}{\text{Change in Income} (\Delta Y)} \]

Relationship between APC and MPC:

The relationship between APC and MPC can be established with the help of a schedule and a diagram. Let’s assume a linear consumption function: \(C = 100 + 0.75Y\), where 100 is autonomous consumption and 0.75 is the MPC.

Example with a Schedule:

Income (Y)	Consumption (C)	APC = C/Y	MPC = ΔC/ΔY
0	100	-	-
100	175	1.75	0.75
200	250	1.25	0.75
300	325	1.08	0.75

Observations from the schedule:

1. APC falls as income increases. At low income levels, consumption can be higher than income (APC > 1), financed by savings. As income rises, the proportion of income consumed falls.
2. MPC is constant for a linear consumption function (0.75 in this case). This means that for every additional $1 of income, $0.75 is consumed.
3. APC is always greater than MPC. This is because APC includes autonomous consumption (consumption at zero income), which is averaged over the entire income. MPC, on the other hand, only relates to the change in income.

Explanation with a Diagram:

• The MPC is the slope of the consumption curve (C). For a straight-line consumption curve, the slope is constant.

• The APC at any point on the consumption curve is the slope of a line drawn from the origin to that point. In the diagram, the slope of the line OA gives the APC at point A. The slope of the line OB gives the APC at point B.

 • As income increases from Y1 to Y2, the slope of the line from the origin to the consumption curve decreases (the line becomes flatter). This shows that APC falls as income rises.

• Visually, the consumption curve (C) is flatter than the lines drawn from the origin to points on the curve (like OA). This confirms that APC > MPC