CH24 Consumption

Question 1

Into what two goods can consumption be divided into?

Answer 1

into spending on durable goods and non-durable goods

Question 2

What does the consumption function show?

Answer 2

it shows the relationship between consumption and its determinants, the main one being income

Question 3

What is consumption affected by? (there’s 7)

Answer 3

by:
-income
-changes in interest rates
-consumer confidence
-wealth
-the availability of credit
-inflation
-the composition of households

Question 4

What is the definition of consumption in economics?

Answer 4

it is the spending on consumer goods and services over a period of time

Question 5

What are durable goods?

Answer 5

durable goods are goods which, although bought at a point in time, continue to provide a stream of services over a period of time. E.g. a car

Question 6

What are non-durable goods?

Answer 6

goods and services which are used up immediately or over a short period of time, like an ice cream or packet of soap powder

Question 7

What is saving?

Answer 7

saving is what is not spent out of income

Question 8

What is name of the relationship between consumption and the factors which determine how much a household consumes?

Answer 8

the consumption function

Question 9

What is the most important determinant of consumption?

Answer 9

disposable income

Question 10

What happens to household consumption if its income rises?

Answer 10

economic theory predicts that the household consumption will rise

Question 11

Can you measure by how much consumption will change due to a change in income?

Answer 11

yes, by the marginal propensity to consume (MPC)

Question 12

What is the formula to calculate the marginal propensity to consume?

Answer 12

MPC = change in consumption / change in income

Question 13

What does the Average Propensity to consume measure? (APC)

Answer 13

measures the average amount spent on consumption out of total income

Question 14

What is the formula for APC?

Answer 14

APC = consumption / income

Question 15

What is the Keynesian theory of consumption?

Answer 15

it is the theory that income is the most important determinant of consumption. Keynesians suggested that as income rose, households would prefer to save more and so the average propensity to consume would decline. Also, higher income households would save a larger proportion of their income that lower income households. Redistributing income from high income earners to those on low incomes would therefore increase total consumption in the economy

Question 16

In a rich industrialized economy, what is the APC likely to be like?

Answer 16

it is likely to be less than 1 because consumers will also save part of their earnings

Question 17

How can interest rates affect consumption?

Answer 17

much of the money to buy durable goods comes from credit finance. An increase in the rate of interest increases the monthly repayments on these goods. This means that, effectively, the price of these goods has increased. Households react to this by reducing their demand for durables and thus cutting their consumption
-a rise in the rate of interest reduces the value of stocks and thus reduces the value of household wealth. This in turn leads to a fall in consumption

Question 18

How does consumer confidence affect consumption?

Answer 18

purchases of consumer durables and non-essential items like holidays are affected by consumer confidence. If consumers expect their situation to be the same or better in the future, they will tend to maintain or increase their spending. If they expect it to get worse, they are likely to hold back on purchases of non0essential items. In a boom, consumer confidence increases, boosting spending

Question 19

What happens to consumer confidence during a recession?

Answer 19

it deteriorates. Some workers worry that they might lose their job. Others worry that their take home pay will fall because they will work less overtime or their bonuses will be cut. They might also worry that banks will refuse to lend them money and so they don’t apply

Question 20

How do wealth effects affect consumption?

Answer 20

If the wealth of a household increases, consumption will increase. This is known as the wealth effect.

Question 21

What are the 2 parts that the wealth of a household is made up of?

Answer 21

1) physical wealth: made up of items such as houses, cars and furniture
2) monetary wealth: comprised of items such as cash, money in the bank and building societies, stocks and shares, assurance policies and pension rights.

Question 22

What are the 2 important ways in which the wealth of a household can change over a short period of time?

Answer 22

1) a change in the price of houses. If the real price of houses increases considerably over a short period of time, as happened in the UK from the mid-1990’s to 2007, then households fell able to increase their spending. They do this mainly by borrowing more money secured against the value of their house
2) a change in the value of stocks and shares. Households react to an increase in the real value of a households portfolio of securities by selling part of the portfolio and spending the proceeds

Question 23

How does the availability of credit affect consumption?

Answer 23

-interest rates are not the only determinant of how much households borrow.
-governments in the past have imposed restrictions on the availability of credit. For instance, they have imposed maximum repayment periods and minimum deposits
-when these restrictions are abolished, households increase their level of debt and spend the proceeds.
-making credit more widely available will increase consumption

Question 24

How does inflation affect consumption?

Answer 24

inflation, a rise in the general price level, has two effects on consumption.
1) if households expect prices to be higher in the future they will be tempted to bring forward their purchases. So expectations of inflation increase consumption and reduce saving
2) however, this can be outweighed by the effect of inflation on the wealth. Rising inflation tends to erode the real value of money wealth. Households react to this by attempting to restore the real value of their wealth (i.e. they save more). This reduces consumption

Question 25

How does the composition of households affect consumption?

Answer 25

young people and old people tend to spend a higher proportion of their income than those in middle age
-so if there is a change in the age composition of households in the economy, there could well be a change in consumption and savings, The more young and old the households, the greater will tend to be the level of consumption

Question 26

Why is income less important in determining saving than it is in determing consumption in Western European countries?

Answer 26

this is because a typical average propensity to save (APS) is 0.05 to 0.2 in Western European countries

Question 27

What is the difference between saving and savings?

Answer 27

saving is a flow concept which takes place over a period of time. Saving is added to a stock of savings fixed at a point in time. Whereas a households stock of savings is the accumulation of past savings