Consumption (C) (Edexcel A Level Economics A)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
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
Examiner Tips and Tricks
Higher interest rates reduce discretionary income and vice versa
Discretionary income = Disposable income - Mortgage interest repayments
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
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