2.2.2 - Consumption (C)

Question 1

** Disposable Income & Consumption**

Answer 1

Disposable income is the income that an individual receives after paying all of their taxes and after they have received any transfer payments. As consumers have more disposable income they are likely to increase their spending. This increases consumption within an economy and therefore AD increases.

Question 2

Savings & Consumption

Answer 2

Question 3

First influence on consumer spending

Answer 3

●** Interest rates**

A ** decrease in interest rates** will reduce the cost of borrowing for consumers. As a result of this, they are more likely to take out loans for consumption purposes.

• Furthermore, a low interest ratereduces the return on savings . Therefore, consumers have less incentive to save their money, increasing the marginal propensity to consume.

Another impact of lower interest rates is a reduction in the amount of interest that consumers have to pay on existing loans such as variable rate and tracker mortgages. This will leave consumers with more disposable income. Overall, these effects will lead to an increase in the total consumption within an economy, leading to an increase in AD, which is the reason why low interest rates are often adopted during times of economic downturn. An increase in interest rates can cause the demand for houses to decrease as the cost of taking out a mortgage increases. This can cause house prices to fall, creating a negative wealth effect in the economy and reducing consumer consumption.

Question 4

Second influence on consumer spending

Answer 4

● Consumer confidence

As consumer confidence increases, so will their marginal propensity to consume. For example, if there is low unemployment within the economy due to increased economic growth, consumers will feel more secure in their current jobs. Therefore, consumers won’t save as much of their disposable income as they feel confident that they will have a regular source of income for the considerable future. This will lead to an increase in consumer consumption and therefore AD

In a weakening or recessionary economy, consumer confidence falls
Consumers feel less secure in their jobs
Consumption decreases and saving increases

Question 5

Third influence on consumer spending.

Answer 5

●Wealth effects

Changes in the economy such as an increase in house prices or an increase in share prices can make consumers wealthier. This causes consumers to become more confident financially and therefore consumers are encouraged to increase their spending. Furthermore, consumers may decide to sell their wealth (e.g. stocks) at their higher price, thus giving consumers more money to spend on goods/services. This will lead to an increase in consumption and AD.

Question 6

How does the negative wealth effect occur ?

Answer 6

• Interest rates rise.
• Less spending and more saving.
• Fall in demand for assets such a stock, and fall in demand for mortgages,
• Fall in demand for houses and assets as people don’t have the money to buy it.
• Lead to a fall in price for houses and assets.
• Which will lead to the negative wealth effect, as house prices and asset prices go down.
• Leading to a further fall in consumption as people don’t feel as wealthy.

Question 7

How does the positive wealth effect occur ?

Answer 7

– dcrease intrest rates rise.
- Less saving and more spending.
- Rise in demand for assets such a stock, and rise in demand for mortgages,
- Rise in demand for houses and assets as people have the money to buy it.
- Lead to a increase in price for houses and assets.
- Which will lead to the positive wealth effect, as house prices and asset prices increase.
- Leading to a further increase in consumption as people feel more wealthy.