2.2.2 Consumption (C) Flashcards
Consumption
total spending by households on goods and services in the economy
What did John Maynard Keynes suggest in his influential book The General Theory of Employment , Interest and Money?
that the most important determinant of consumption is disposable income
Disposable income
the income that households have to devote to consumption and saving , taking into account payments of direct taxes and transfer payments
What effect does a rise in disposable income have?
A real incomes rise , households will tend to spend more . However , Keynes also pointed out that they would not spend all of an increase in income , but would save some of it .
Average propensity to save
the proportion of income that households devote to saving
Marginal propensity to consume ( MPC )
the proportion of additional income devoted to consumption
Marginal propensity to save ( MPS )
the proportion of an increase in disposable income that households would devote to saving
Average propensity to consume ( APC )
the average amount spent on consumption out of total income
Savings
what is not spent out of income
Formula for MPC
change in consumption/change in income
Formula for APC
consumption/income
Formula for MPS
change in saving/change in income
Formula for APS
saving/income
Reasons for saving
- For a rainy day
- Unexpected expenses or events
- Planned expenses or events
- Retirement ( excluding pension)
- In case of household income changes
The household savings ratio
measures the amount of money that households have available to save . The savings ratio is measured as a percentage of total disposable income .
Key factors influencing household saving
Real Interest Rate : The nominal interest rate adjusted for inflation . A positive real interest rate incentivises saving
Price Expectations : If consumers expect prices to fall ( i.e. deflation ) they may choose to save more now
Availability of Credit : Borrowing is counted as dis - saving as spending > current income
Unemployment / Job Security : When unemployment is rising , people save more as a precaution as job security declines
Consumer Confidence : When consumer confidence is strong , then people are more willing to borrow and save less
Taxation of Savings : Interest on saving is taxed , some savings schemes such as ISAs are tax - free or low tax
Trust in Savings Institutions : Deposit guarantees for people can encourage more saving in commercial banks because the risk is reduced .
Influences on consumer spending
- Interest rates
- Availability of credit
- Asset prices
- Consumer confidence
- Wealth effects
- Level of disposable income
How do interest rates affect consumer spending?
Most major purchases are made on credit, so interest rates significantly impact consumer costs. Higher interest rates lead to higher prices and reduced consumption. They also increase mortgage repayments, further reducing consumption. Additionally, rising interest rates decrease the value of shares, causing a negative wealth effect. Low credit availability reduces the impact of lower interest rates as banks are reluctant to lend.
How does consumer confidence affect consumer spending?
- Consumer confidence is affected by job prospects and the level of unemployment
- 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.
- 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.
- Consumer confidence surveys measure changes in consumer attitudes, including expectations of the economic situation and households’ own financial positions, and their views on making major purchases such as a new car or spending on expensive home improvements.
How does the wealth effect affect consumer spending?
People with greater wealth tend to consume more, known as the wealth effect. This occurs when real house prices rise, making owners more confident in spending since they can borrow against their houses, which are worth more than their current mortgages. Similarly, rising share prices can lead to increased spending as owners may sell shares and use the proceeds or feel more confident in spending due to the shares as a safety net. Greater wealth boosts consumer confidence and leads to increased spending. Changes in asset prices like property and shares can trigger the wealth effect.
Wealth
a stock of assets , such as a house , shares , land , cars and savings . This is different to income which is the money you are paid each week or month .
consumption function
the relationship between consumption and disposable income; its position depends on the other factors that affect how much households spend on consumption. MPC is the slope of this line
Non durable goods
Non durable goods are consumed over a short period of time
Durable goods
Durable goods are consumer products that are not consumed or that yield utility over long periods of time
Consumer confidence
Expectations about the future including interest rates , incomes and jobs
Original income
Income from jobs , private pensions , interest from savings
Gross income
Gross income is original income + cash benefits
Household wealth
The monetary value of assets - including property , shares , savings , pension fund assets .
Negative equity
When the value of an asset falls below the debt left to pay on that asset . Term is most commonly used in connection with property prices after a slump in house prices .
Pension Fund
Fund that pools employees’ pension benefits and holds them so that they can be paid at retirement. The money is invested in stocks, bonds, and other assets to boost returns and ensure that there are sufficient funds to be paid out.
Personal allowance
The amount of income you can earn before you start paying income tax . It is £ 12,500 in 2019 .
Precautionary saving
Saving because of fears of a loss of real income or rising unemployment
Unsecured credit
Credit not secured by another asset, i.e. money borrowed on credit cards
