2.2.2 Consumption (C) Flashcards
Consumption
The total amount spend by households on goods and services. It does not include spending by firms.
What does an increase in consumption do to AD?
Increases AD
- Evaluation point: A rise in AD has the potential to create inflation.
How significant is changes in consumption to AD?
Consumption is the largest component of AD - it makes up 65% of AD in the UK. This means that changes in the level of consumption have a big impact on AD.
Main factors affecting consumption and saving
- Disposable Income
- Interest rates
- Consumer confidence
- Wealth effects
- Taxes
- Unemployment
[Factors affecting consumption and saving]
How do interest rates affect consumption and saving?
Higher interest rates lead to less consumer spending. Consumers save more to take advantage of the higher rates and they’re less likely to borrow money or buy things on credit because it’s more expensive. Consumers may also have less money to spend if interest rates on existing loans and mortgages increase.
[Factors affecting consumption and saving]
How does consumer confidence affect consumption and saving?
When consumers feel more confident about the economy and their own financial situation, they spend more and save less. Confidence is affected by a number of factors. For example, in a recession consumers are usually reluctant to spend because their confidence in the economy is loss – they might, for example, be worried about losing their jobs. This reluctance can continue even after a recession.
[Factors affecting consumption and saving]
How does the wealth effect affect consumption and saving?
A rise in household wealth (e.g. due to a rise in house prices or share prices) will often lead to a rise in consumer spending and a reduction in saving. This is because of consumer confidence – if house prices rise faster than inflation, home owners will feel more confident in their own finances.
[Factors affecting consumption and saving]
How do taxes affect consumption and saving?
Direct tax increases lead to fall in consumers’ disposable income, so they spend less. Indirect tax increases, e.g. an increase in VAT, increase the cost of spending, so consumers tend to reduce their consumption. A reduction in direct or indirect taxes will lead to an increase in consumer spending.
[Factors affecting consumption and saving]
How does unemployment affect consumption and saving?
When unemployment rises, consumers tend to spend less and save more. (People still in employment will tend to replace spending with saving, as they become more worried about losing their jobs). A fall in unemployment means more people have money to spend, and consumers are less worried about losing their jobs, so consumer spending increases.
[Factors affecting consumption and saving]
How does disposable income affect consumption and saving?
Generally, as disposable incomes increase, consumption will rise. The rate at which consumption rises is usually lower than the rate at which income increases because households tend to save more as well.
