Question

a) What is meant by average propensity to consume? b) Suppose that $$\$ 1000$$ out of $$\$ 10,000$$ disposable income is saved. What is the average propensity to consume?

Short answer

The average propensity to consume (APC) is the proportion of disposable income spent on consumption, calculated as the total consumption divided by the total disposable income. In this case, with \(\$ 9,000\) spent on consumption and a total disposable income of \(\$ 10,000\), the APC is 0.9 or 90%. This means that 90% of the disposable income is spent on consumption, while 10% is saved.

Step-by-step solution

Definition of Average Propensity to Consume

The average propensity to consume (APC) is an economic concept that represents the proportion of disposable income that is spent on consumption. It is calculated as the total consumption divided by the total disposable income. In other words, APC shows how much an individual or economy, on average, tends to consume out of their disposable income.

Calculating Consumption and Disposable Income

Given that \(\$ 1000\) of the \(\$ 10,000\) disposable income is saved, we can determine the amount spent on consumption by subtracting the savings from the total disposable income. That is: Consumption = Total Disposable Income - Savings With the data provided: Total Disposable Income = \(\$ 10,000\) Savings = \(\$ 1,000\) Now, we can calculate the consumption: Consumption = \(\$ 10,000\) - \(\$ 1,000\) = \(\$ 9,000\)

Calculating the Average Propensity to Consume

Now that we have the consumption and disposable income, we can calculate the average propensity to consume using the formula: APC = Consumption / Total Disposable Income Plugging in the values we calculated: APC = \(\$ 9,000\) / \(\$ 10,000\) APC = 0.9 or 90% The average propensity to consume is 0.9 or 90%. This means that on average, 90% of the disposable income is spent on consumption, while the remaining 10% is saved.

Key concepts

Understanding the Economic Concept of Average Propensity to Consume

The notion of average propensity to consume (APC) is essential for understanding consumer spending behavior. It denotes the fraction of disposable income that individuals or households spend on goods and services rather than saving. This economic indicator helps economists gauge the tendency of a population to spend, which can have significant implications for economic policies and businesses.

To put it practically, consider a family with a certain monthly income after taxes and other mandatory charges—this is their disposable income. The average propensity to consume is found by taking the family's consumption expenditures on needs and wants and dividing it by their disposable income. A higher APC suggests that the family prioritizes spending over saving, providing insights into their economic prioritization and potential reactions to changes in income or tax policies.

Disposable Income: The Foundation for Consumption and Saving Decisions

In economics, the concept of disposable income is the amount of money that individuals or households have available for spending and saving after accounting for income taxes. It is the net income that can be put to either consumption or savings. The key here is the notion of choice—individuals can either spend this money on immediate needs and wants, like groceries, utilities, and entertainment, or they can choose to save for the future such as for retirement, emergency funds, or investment.

Disposable income is a fundamental concept because it directly influences people's ability to participate in the economy. When people have more disposable income, they may be inclined to spend more, boosting economic activity. Conversely, if disposable income decreases due to higher taxes or lower gross income, individuals might restrict their spending, which could slow down economic growth.

Consumption Spending: Driving the Economy Forward

The term consumption spending refers to the total amount of money spent by households on goods and services. This category is a primary engine of an economy, propelling growth and development. Consumption includes spending on necessities like food and housing and non-essentials or luxury items, contributing to a diverse economic landscape.

Understanding consumption spending patterns offers valuable insights into the health of an economy. When consumers are confident and have sufficient disposable income, they tend to spend more, leading to increased production, job creation, and overall economic vitality. On the other hand, when consumer confidence wanes or disposable income shrinks, spending may decrease, which can lead to a slowdown in economic momentum.