GEC- PRINCIPLES OF
MACROECONOMICS
PROJECT- CASE STUDY
Name: Ishtasha Joshi
Roll. No.: 24/MMC/20
CONCEPT
Average Propensity* to Consume (APC): The proportion of total
income that households spend on consumption. It essentially tells
us what percentage of their income, on average, people are
APC can be greater than 1: This happens when
consumption expenditure exceeds income. This is possible in
the short run if people borrow or use past savings to maintain
their consumption levels. This is referred to as dissaving.
APC can never be zero: Even at zero income, there's
typically some level of autonomous consumption (essential
spending for survival), so consumption cannot be zero.
APC tends to fall as income rises: While consumption
generally increases with income, it usually doesn't increase at
the same rate. This means the proportion of income spent on
using to buy goods and services.
Formula: APC= Total Consumption (C) / Total Income (Y) …….(1)
Average Propensity* to Save (APS): The proportion of total
income that households save. It indicates what percentage of
APS can be negative: This occurs when savings are negative,
meaning consumption expenditure is greater than income
(dissaving).
APS can be zero: This happens when all income is spent on
consumption, and there are no savings. This is known as the
break-even point.
APS can never be greater than 1: One cannot save more
than their total income.
their income, on average, people are setting aside rather
than spending.
Formula: APS= Total Savings (S) / Total Income (Y) …….(2)
*Propensity- The natural tendency to behave in a certain way
NOTE
Generally, lower-income households tend to have a higher APC because
they need to spend a larger portion of their income on necessities. As
income increases, people tend to save a larger fraction hence higher-
income households generally have a higher APS because they can afford
to save a larger fraction of their income after meeting their consumption
needs.
-Relationship between APC and APS
A fundamental relationship exists between APC and APS because income
is either consumed or saved (assuming no taxes or transfers occur for
simplicity):
Y (Income) = C (Consumption) +S (Saving)
If we divide both sides of this equation by total income (Y), we get:
Y/Y=C/Y + S/Y [From (1) and (2)]
1=APC+APS
CASE STUDY
India’s Rising Middle-Class and
Consumption Boom: An
Analysis with APC and APS
India is currently witnessing a significant expansion of its middle class,
which is fuelling a substantial consumption boom. This phenomenon has
interesting implications for the macroeconomic concepts of the Average
Propensity to Consume (APC) and the Average Propensity to Save (APS).
Delving into the detailed analysis, we find:
1. The Rise of India's Middle Class: A Key Driver of Consumption
Definition and Growth: Defining the middle class varies, but
generally, it encompasses households with a certain range of
disposable income that allows for discretionary spending beyond
basic necessities. Estimates suggest a rapid growth, with projections
indicating that the middle class could constitute a significant portion
of India's population by the mid-21st century almost 60% by 2047.
Drivers of Growth: Several factors contribute to this expansion:
o Economic Growth: Sustained economic growth over the past
few decades has led to increased per capita income and lifted
millions out of poverty.
o Urbanization: Migration from rural to urban areas provides
better employment opportunities and higher income levels.
o Education and Technology: Increased access to education
and technology enhances skills and earning potential.
o Demographic Dividend: A large young population entering
the workforce contributes to a growing earning base.
Impact on Consumption: As more households enter the middle-
income bracket, their purchasing power increases significantly. This
leads to a surge in demand for a wide range of goods and services,
including:
o Consumer Durables: Appliances, electronics, automobiles.
o Discretionary Spending: Entertainment, travel, dining out,
branded apparel.
o Services: Healthcare, education, financial services.
o Premium Goods: Higher-quality and aspirational products.
2. Implications for Average Propensity to Consume (APC)
Initial Increase in APC: As households transition from lower-
income to middle-income status, they often experience a significant
increase in their APC. This is because a larger portion of their
increased income goes towards fulfilling unmet needs and desires
for a better quality of life. They may prioritize purchasing essential
goods they previously couldn't afford and invest in durable goods.
Stabilization and Potential Decrease in APC: As the middle
class matures and income levels become more stable, the rate of
increase in consumption may slow down relative to income growth.
Once basic and aspirational needs are met, a larger portion of
additional income may be directed towards savings and
investments, leading to a stabilization or even a gradual decrease in
the overall APC of the middle-class segment.
Heterogeneity within the Middle Class: It's crucial to recognize
that the Indian middle class is not a homogenous group. Different
income levels within this segment will exhibit varying APC levels.
The lower middle class might still have a relatively high APC, while
the upper middle class will likely have a lower APC compared to
their income.
Influence of Consumerism and Credit: The rise of consumer
culture, facilitated by easier access to credit and various financing
options, can influence the APC. Households might be inclined to
consume more, even if it means taking on debt, potentially keeping
the APC higher than it would otherwise be.
3. Implications for Average Propensity to Save (APS)
Initial Decrease in APS: Corresponding to the initial increase in
APC, the APS of households entering the middle class tends to
decrease. A larger proportion of their income is directed towards
consumption, leaving a smaller fraction for savings.
Subsequent Increase in APS: As income levels stabilize and the
urgency to fulfil immediate consumption needs diminishes, the APS
of the middle class is expected to rise. With greater financial
security, households can focus more on long-term financial goals
like education for their children, retirement planning, and asset
accumulation.
Factors Influencing APS: Several factors can affect the saving
behaviour of the middle class:
o Financial Literacy: Higher financial literacy can lead to
better saving and investment decisions, increasing APS.
o Investment Opportunities: Availability of attractive and
accessible investment options can incentivize saving and
increase APS.
o Economic Outlook: Uncertainty about the future economic
outlook might lead to precautionary saving, increasing APS.
This graph shows that as the income
of the middle class rises, their
consumption expenditure also
increases. However, the slope of the
consumption curve might decrease
over time as a larger proportion of
income is allocated towards savings.
This graph conceptually illustrates the inverse relationship between APC
and APS. As the middle class grows and matures:
APC starts at a higher level (as a larger proportion of initial income
gains are spent), then potentially decreases or stabilizes as income
rises further.
APS starts at a lower level (as a smaller proportion of initial income
is saved), then tends to increase as income becomes more stable
and consumption needs are increasingly met.
Current Trends and Nuances in India's Context
Recent reports suggest that while the middle class in India is
expanding and driving consumption, there are nuances to consider.
Some data indicates that despite rising aspirations and
consumption, middle-class earnings have not grown proportionally
with inflation over the past decade, potentially leading to increased
household debt to maintain lifestyles. This could temporarily keep
the APC higher than anticipated.
The COVID-19 pandemic also had a differential impact, potentially
causing a temporary contraction in the middle class and altering
consumption and saving patterns. However, the long-term trend of a
growing middle class fuelling consumption is expected to continue.
Furthermore, the definition and categorization of the middle class in
India are constantly evolving, making precise measurements of APC
and APS challenging.
Conclusion
The rise of India's middle class is a significant macroeconomic trend
driving a consumption boom. Initially, this expansion leads to a higher APC
and a lower APS as new entrants prioritize consumption to improve their
living standards. However, as the middle class matures and achieves
greater economic stability, their APC is expected to stabilize or gradually
decrease, while their APS should see a corresponding increase.
Understanding these dynamics is crucial for policymakers and businesses
to gauge aggregate demand, savings behaviour, and the future trajectory
of the Indian economy. The interplay between income growth,
consumption patterns, and saving habits of the expanding middle class
will continue to shape India's macroeconomic landscape.
