2.2.2 Consumption (C) Flashcards
Consumption
Consumption is spending on consumer goods and services over a period of time.
Disposable income
Disposable income (Y) is the money consumers have left to spend, after taxes have been taken away and any state benefits have been added. This means that disposable income is affected by government taxation as well as wages.
- It is the most important factor in determining the level of consumption. Those who are earning a large income will be able to spend much more than those on a minimum wage.
Disposable income and its influence on consumer spending (Marginal Propensity to Consume)
We are also concerned with how much an increase in income affects consumption, this is called the marginal propensity to consume (MPC). For most people, MPC will be positive but less than 1 i.e. an increase in income increases spending but spending doesn’t increase by as much as income. Some people will have an MPC of more than one as they use borrowing or savings to fulfil the demand for goods which is higher than their increase in income.
● Poorer people tend to have a higher MPC as they are likely to spend much more of their increase in income whilst richer people are more likely to save it.
Average Propensity to Consume (APC)
The average propensity to consume (APC) is the average amount spent on consumption out of total income. In an industrialised country, the APC for the economy is likely to be less than one as people save some of their earnings.
MPC equation: Consumption
MPC = change in consumption / change in income
APC: consumption
APC = total consumption / total income
Relationship between Savings and Consumption
● Savings is what is not spent out of income. An increase in consumption decreases savings so the same factors which affect consumption are those which affect savings- but in the opposite way. For example, a rise in confidence will decrease savings.
Marginal propensity to save MPS and equation
The marginal propensity to save (MPS) is how much of an increase in income is saved.
MPS = change in savings / change in income
Average Propensity to Save APS and equation
The average propensity to save (APS) is the average amount saved out of income.
APS = total savings / total income
Other influences on consumer spending
- Interest rates
- Consumer confidence
- Wealth effects
- Distribution of income
- Tastes and attitudes
Interest rates: influence on consumer spending
Most major expenditures are bought on credit so therefore the interest rate will affect the cost of the good for consumers. If interest rates are high, the price of the good will effectively be higher since more interest needs to be paid back and this will lead to a reduction in consumption. High interest rates also increase mortgage repayments so reduce consumption. Also, a rise in interest rates decreases the value of shares and so people experience a negative wealth effect.
Consumer confidence: influence on consumer spending
One major factor that affects people’s spending is what they think will happen in the future. If people are confident about the future and expect pay rises, then they will continue or increase their spending. If they expect high levels of inflation in the future, they will buy now as it will be at a cheaper price, so consumption will increase. If they expect a recession and fear possible unemployment, consumption will decrease as people may save more. Expectations about a change in the taxation level will affect consumption: if consumers expect tax to increase prices in the future, they will buy now whilst if they expect it to reduce prices in the future, they will delay their purchases. Similarly, expectations on interest rates will affect consumption: if consumers expect interest rates to fall they may delay their purchases as things on credit will be cheaper.
Wealth effects: influence on consumer spending
Wealth is a stock of assets. People with greater wealth tend to have greater levels of consumption, known as the wealth effect: a change in consumption following a change in wealth. The wealth effect is experienced when real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage. It can also be experienced when share prices rise as people may sell some of their shares and spend the money or may be more confident in spending the money they have as they know they have the shares to fall back on in case of financial difficulty. Greater wealth will improve a consumer’s confidence and thus lead to greater spending.
Distribution of income: influence on consumer spending
Those on high incomes tend to save a higher percentage of their income than those on low incomes and so a change in the distribution of money in the economy will affect the level of consumption. If money is moved from the rich to the poor, consumption is likely to increase as the poor have a higher MPC.
Tastes / attitudes: influence on consumer spending
In our modern society, there is a strong materialistic drive that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income. If people were less materialistic, consumption would decrease.
