Consumption
From WikiTextbook
Household spending accounts for approximately two thirds of total aggregate demand for goods and services in the economy. It is not surprising that macro economists spend a large amount of time researching trends in consumer spending as they build up a picture of how the British economy operates.
We can distinguish between different types of consumption:
- Goods
- Services
- Durables
- Non-durables
There is a positive relationship between disposable income and consumer spending.
Consumption Definitions
Average propensity to consume (APC) is the percentage of disposable income spent. To find the percentage of disposable income spent, one needs to divide consumption by disposable income.
The marginal propensity to consume (MPC) is the increase in personal consumer spending that occurs with an increase in disposable income (income after taxes and transfers).
Saving Definitions
Saving is an act of postponing consumption. Total savings (S) = Disposable Income (Yd) - Consumption (C). Gross Income (Y) can be spent (C), saved (S) or paid in tax (T).
The average propensity to save (APS) is the percentage of disposable income saved.
The marginal propensity to save (MPS) is the increase in saving that results from an increase in income, or alternatively the decrease in saving that results from a decrease in income.
The marginal propensity to consume + the marginal propensity to save = 1
The Wealth Effect
The wealth effect is an increase in spending that accompanies an increase in wealth (in absolute terms), or merely a perceived increase in wealth (in relative terms). An example of a real increase in wealth would be a bonus or a pay rise at work; while an example of perceived increase in wealth would be if the value of your house goes up (it is only perceived as you are not really going to sell your house, so will not benefit from its' increase in value).
Inflation and Consumption
Inflation has two effects on consumption: 1) Inflation affects consumer spending because if inflation increased people will have money which is worth less, so they can buy less. 2) Increasing consumption may discourage savings and investments. So, people will consume more instead of saving or investing.
Consumption and the Rate of Interest
When consumer confidence increases and consumers commit to higher levels of spending this is called a cyclical upswing. This happened in 1997-98 and 1998-99 there was a fall in confidence and it picked up in 1999. The Bank of England looks closely at the consumer confidence figures when assessing future movements in demand and output. High confidence levels may be used as evidence to raise interest rates to control the growth of household demand. Lots of economic factors affect the overall state of consumer confidence. Some of these factors include: • The level of interest rates (including mortgage rates) • Changes in unemployment and the state of job security / insecurity • Expectations of inflation • Changes to direct and indirect taxation • Windfall Gains (for example arising from
The Consumption and Savings Function
Consumption and savings function, savings are positively related to the level of disposable income. At low levels of income, total spending may go above income causing dis-saving. As income rises, total savings rise. The gradient of the savings function is given by the marginal propensity to save.
Trends In The Savings Ratio
After the war, the trend in savings ratio was upward because people received more real incomes and their living standards increased, so people saved. In the 1970’s, people saved more because there was high inflation and interest rates. When interest rates and inflation falls there is less of an incentive to save money and more of an incentive to borrow money (this happened in between 1985 and 1988). This causes dis-saving. Also, consumer confidence could increase and they would be prepared to pay more than they own. This would lead to a short term increase in their living standards.
Consumer Confidence
Consumer confidence can determine the levels of spending. The willingness and ability of households to finance their spending can change according to the state of the economy. If there was low unemployment people would not buy high priced items and try to save money.
Friedman's Permanent Income Hypothesis
The main feature of consumption is a person’s real wealth according to Friedman’s permanent income hypothesis. Assets (both physical and human) decide permanent income and these influence a consumer’s ability to earn income.
The theory proposes that consumers try to smooth out consumer spending based on their permanent income. A change in permanent income causes a change in consumption. However, temporary changes in income do not change the long run consumer spending.
Statistics
Videos
BBC news video on consumer spending
Links
Other revision material
Further reading
Contributors
Will Dewing Ben Slater Henry Porter
