Consumption (C) (Edexcel A Level Economics A)

The Influence of Disposable Income On Consumption

• Disposable income is the money that households have left from their salary/wages after they have paid their direct taxes and have received any transfer payments/benefits

  • If direct taxes like income tax increase, then disposable income decreases and vice versa

  • If wages fall, then disposable income decreases, and vice versa

  • If transfer payments to a household increase (e.g. unemployment benefits), then disposable income increases and vice versa

• Consumption increases as disposable income increases

• Consumption decreases as disposable income decreases

The Relationship Between Savings & Consumption

• Disposable income can either be saved or spent on goods/services (consumption)

  • When savings decrease, consumption usually increases

  • When savings increase, consumption usually decreases

• The household savings ratio calculates household savings as a proportion of household income

  • This percentage is often low when an economy is booming and full of confidence and vice versa

  • During lockdown in 2020 this ratio reached a record high in the UK of around 25%

Other Influences on Consumer Spending

Changes to interest rates

• Interest rates are set by the government's Central Bank

  • Changes to the base rate cause commercial banks to change the lending and saving rates they offer customers

• A change in interest rates will change the level of consumer spending and savings

  • If interest rates increase, there is a greater incentive to save and less incentive to borrow

    • More saving = less consumption

    • Less borrowing = less consumption

  • If interest rates increase, the monthly repayment on any loan or mortgage increases

    • Higher loan repayments = less consumption

Changes to consumer confidence

• The stronger the economy, the higher consumer confidence

  • Consumers feel secure in their jobs and are confident of receiving regular salary payments

    • Consumption increases and saving decreases

• In a weakening or recessionary economy, consumer confidence falls

  • Consumers feel less secure in their jobs

    • Consumption decreases and saving increases

Changes to wealth

• If consumer wealth increases, then consumption usually increases

  • Rising property prices or share prices give consumers confidence to borrow more money and spend. This is called the positive wealth effect

    • Increased borrowing = increased consumption

  • After the financial crisis in 2008, the fall in house prices and the stock market crash led to a negative wealth effect. Even households with higher incomes felt poorer, causing them to reduce expenditure on non-essential items