2.2.2 - Cosumption

Question 1

What is aggregate demand?

Answer 1

Aggregate demand is the total amount of goods and services demanded in the economy at a given time and price level.

Question 2

What determines the level of consumption within a household?

Answer 2

• Disposable income
• Interest rates
• Levels of personal debt

Question 3

What is the wealth effect?

Answer 3

This effect states that when the value of a consumer’s assets increases (the value of their house or shares) they tend to spend more.

Question 4

What are interest rates?
What effect do interest rates have on consumption?
What effect do interest rates have on disposable income?

Answer 4

The cost of borrowing.

An increase in rates will make it more expensive to borrow money and increase the attractiveness of saving. This will reduce demand and the amount of consumer spending.

Lower interest rates cuts the cost of paying the debt on a mortgage and increases the effective disposable income of homeowners. During times of low growth, central banks around the world have made deep cut in interest rates in a bid to stimulate consumer demand.

Question 5

What is consumer confidence?

Answer 5

This is the confidence which consumers have in their short, medium or long term economic prospects. For example, if a consumer believes that their job is safe they will tend to spend more. Also, if a consumer believes that they will receive a promotion (which most likely means higher pay) they will be more likely to spend more.

Question 6

What is disposable income?

Answer 6

This is gross income less income tax and national insurance contributions plus cash welfare benefits. Disposable income is the money that comes into a household from various sources, including welfare benefits but after taxes on income.

Question 7

What effect do levels of personal debt have on consumption?

Answer 7

Levels of personal debt is a debt which the person has. The higher this debt is the less consumption there’ll be as most of that consumer’s income will be tailored towards repayments.

Question 8

What effect do levels of personal wealth have on consumption?

Answer 8

Individuals with higher levels will tend to consume more as they can borrow funds against the value of assets e.g. their house.

Question 9

What is marginal propensity to consume?

Answer 9

The proportion of an change in income that is spent rather than saved.

Question 10

What is marginal propensity to save?

Answer 10

The change in total saving as a result of a change in income.

Question 11

Name 2 things that affect savings and explain one of them.

Answer 11

• Interest rates as higher interest rates increase the incentives to save as the reward is greater
• Confidence because if individuals and workers are nervous about the future, they may be inclined to save more of their income in the event of wage cuts, wage freezes or
  redundancy
• Inflation because if prices are rising quickly, then the real value of savings is eroded, so the incentive to save reduces

Question 12

Name 2 things that have an effect on consumption

Answer 12

• Interest rates

- Marginal propensity to consume

Question 13

What is marginal propensity to consume?

Answer 13

This is the proportion of money which a consumer is willing to spend.

For example, if you have £10 are you going to spend the whole thing or £2 on McDonalds.

Question 14

Name 2 of the main things that have an effect on the level of consumption

Answer 14

• Disposable income
• Marginal propensity to consume (MPC)
• Interest rates
• Wealth effect
• Consumer confidence

Question 15

What’s one evaluation point that can be used for interest rates?

Answer 15

There are time lags between changes in interest rates and their effect on consumption.