average and marginal propensities to consume (apc and mpc)

🍰 The Circular Flow of Income

What’s the Circular Flow?

Think of the economy like a giant pizza shop. 🍕 Households (you and your friends) buy pizza slices (consumption, C). The shop (firms) makes the pizza using ingredients (factors of production) and pays the workers (households) wages (income, Y). The money flows back to the shop as it buys more ingredients, and the cycle continues.

Average Propensity to Consume (APC)

Definition: APC = \$\\displaystyle \\frac{C}{Y}\$

It tells you what proportion of total income is spent on consumption.

Income (\$Y\$)Consumption (\$C\$)APC
£10,000£7,000\$\\displaystyle \\frac{7000}{10000}=0.70\$ (70%)

📌 Tip: APC is always < 1 because you can’t spend more than you earn.

Marginal Propensity to Consume (MPC)

Definition: MPC = \$\\displaystyle \\frac{\\Delta C}{\\Delta Y}\$

It shows how much consumption changes when income changes by one unit.

Income Change (\$\\Delta Y\$)Consumption Change (\$\\Delta C\$)MPC
£100£50\$\\displaystyle \\frac{50}{100}=0.50\$

💡 Remember: If you earn an extra £1, MPC tells you how many of those £1 you’ll spend.

Relationship Between APC and MPC

  • APC < 1 (you can’t spend more than you earn).

  • MPC ≤ APC (the extra money you earn is usually spent less than the total proportion of your income).

  • Both are positive in a normal economy.

Exam Tips & Tricks

🔍 When you see:

  1. C and Y given: calculate APC using \$C/Y\$.

  2. Changes in C and Y given: calculate MPC using \$\\Delta C/\\Delta Y\$.

  3. Graph of C vs Y: slope of the line = MPC.

📝 Tip: Always check units (e.g., £) and remember that APC is a ratio, while MPC is a rate of change.

Quick Quiz

  1. If a household earns £8,000 and spends £5,200, what is the APC?

  2. Income rises from £9,000 to £9,200 and consumption rises from £6,000 to £6,100. What is the MPC?

  3. Explain in one sentence why APC is always less than 1.