2.2.2 Consumption

Question 1

What is Disposable Income and Its Influence on Consumer Spending?

Answer 1

• Disposable income is the income left over for an individual or household after taxes have been paid. It is a crucial determinant of consumer spending.

Relationship Between Disposable Income and Consumer Spending: Generally, as disposable income increases, consumer spending tends to rise.
This relationship is explained by the marginal propensity to consume (MPC), which is the proportion of an additional dollar of income that a consumer spends.
If MPC is 0.8, it means that for every additional dollar of disposable income, the consumer will spend 80 cents and save 20 cents.

Question 2

What is the relationship between savings and consumption?

Answer 2

Savings are the portion of income that is not spent on consumption. There is an inverse relationship between savings and consumption:

• When consumers save more (increase savings), they spend less on consumption.
• When consumers save less (decrease savings), they spend more on consumption.

Question 3

What are some other influences on Consumer Spending?

Answer 3

1. Interest Rates: Lower interest rates tend to stimulate consumer spending because borrowing costs are reduced. For example, when mortgage interest rates are low (and people have a variable rate mortgage linked to the base rate of interest), more people may take out loans, leading to increased spending on big ticket items.
2. Consumer Confidence: Consumer confidence reflects the optimism or pessimism of consumers about the future of the economy. Higher consumer confidence generally leads to increased consumer spending, as people are more willing to make major purchases when they believe the economy is doing well. This is related to Unemployment levels and Job prospects in the economy (# of job vacancies).
3. Wealth Effects: When the value of assets such as homes or stocks increases, consumers tend to feel wealthier and spend more. Conversely, during a financial crisis, declining asset values can lead to reduced consumer spending.
4. Level of disposable income: this is impacted by income tax levels and wage rates
5. Household indebtedness: If many households are severely or mildly indebted they may have a smaller marginal propensity to consume as they seek to save up money in case of economic or financial crises.