The Unassuming Economist

From a post by by Jay Kulkarni and Susan Thomas:

The economic well-being of households is primarily about their ability to spend on consumption. Household consumption is dominated by what the income of the household is, but not limited by it. Households that spend less than they earn, build their savings. Households that spend more than they earn either borrow or draw down on earlier savings. There is a big difference in the life-cycle possibilities between households that manage to save versus those that do not. In this article, we analyse a panel dataset of Indian households to understand what differentiates households who live within, or beyond, their means.

An often discussed measure of the household’s income-consumption dynamic is the `marginal propensity to consume’ or MPC, which is the marginal change in consumption for a marginal change in income. The MPC is a valuable part of the toolkit of macroeconomics. An equally important measure is the ‘average propensity to consume’ (which is abbreviated as APC). This is the fraction of disposable income that the household consumes. The APC shows the income-consumption dynamics of a household in a stated time period. When the APC is below 1, the household is saving, and on average, building up its wealth. There is a clear line between low APC households (i.e. those with APC below 1), who are building up wealth, vs. the households that are not.

In an advanced economy, we think of the APC as a part of life cycle optimisations. When an affluent and financial unconstrained household is young, it builds up savings (i.e. low APC), and then it dis-saves in old age (i.e. high APC). In a poor country, we see many households who are dis-saving even when they are young. Building up wealth versus drawing down wealth takes on a different character in the context of a low middle income economy (Badarinza et al, 2019).

Aggregate facts about household APC, and its covariates, are an important element of understanding India. This article aims to establish such facts. What is the average household APC in India? What fraction of households have a low APC? Do higher income households have a low APC? Do low APC households have lower income volatility? Are low APC households systematically older households? What is the connection between financial inclusion and household APC?”

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