Aggregate Demand (AD) (Edexcel A Level Economics A)

With reference to extract A and the concept of disposable income', explain the impact of a rise in interest rates for consumers with credit cards

Extract A

UK household consumption

Despite the slow growth in real household disposable incomes, consumer spending rose in 2017. Annual spending per person increased by £589, when compared with 2016. This may have reflected UK households’ delay in adjusting to the increase in inflation that was associated with the fall in the exchange rate of the British pound. The increase in consumption has also been driven by low interest rates. In 2017 UK house prices increased by an average of 5.1%. UK consumers have financed most of their spending by borrowing on credit cards in order to maintain their living standards. In 2017 borrowing on credit cards rose by 9.6%, the second-highest level since before the financial crisis. This has increased the Bank of England’s concerns about the sustainability of borrowing, given the slow growth in real incomes. The Bank has also indicated that the base interest rate was likely to rise faster than previously expected. More expensive credit could therefore constrain the ability of households to spend.

(Source: adapted from ‘Consumer Trends UK’, ONS, https://www.ons.gov.uk/economy/ nationalaccounts/ satelliteaccounts/bulletins/consumertrends/octobertodecember2017 and © Crown copyright 2018)

Figure 2: UK real household consumption, quarterly, £ billions, 1997 to 2018

Extract A

UK household consumption

Despite the slow growth in real household disposable incomes, consumer spending rose in 2017. Annual spending per person increased by £589, when compared with 2016. This may have reflected UK households’ delay in adjusting to the increase in inflation that was associated with the fall in the exchange rate of the British pound. The increase in consumption has also been driven by low interest rates. In 2017 UK house prices increased by an average of 5.1%. UK consumers have financed most of their spending by borrowing on credit cards in order to maintain their living standards. In 2017 borrowing on credit cards rose by 9.6%, the second-highest level since before the financial crisis. This has increased the Bank of England’s concerns about the sustainability of borrowing, given the slow growth in real incomes. The Bank has also indicated that the base interest rate was likely to rise faster than previously expected. More expensive credit could therefore constrain the ability of households to spend.

(Source: adapted from ‘Consumer Trends UK’, ONS, https://www.ons.gov.uk/economy/ nationalaccounts/ satelliteaccounts/bulletins/consumertrends/octobertodecember2017 and © Crown copyright 2018)

With reference to Figure 2 and Extract A, explain two likely influences on the level of UK real household consumption

With reference to Extract A, explain two influences on the net trade balance for an economy 

Extract A

Rwandan tariffs on imports of used clothing

In a market in Kigali, Rwanda’s capital, an auction is under way. Sellers offer crumpled T-shirts and faded jeans; traders argue over the best picks. Everything is second-hand. A Tommy Hilfiger shirt sells for 5000 Rwandan francs ($5.82); a plain one for a tenth of that. Afterwards, a trader sorts through the purchases he will resell in his home village. The logos hint at their previous lives: Kent State University, a rotary club in Pennsylvania, Number One Dad. These auctions were once twice as busy, but in 2016 Rwanda’s government increased import tariffs on a kilo of used clothes from $0.20 to $2.50. Now many traders struggle to make a profit. The traders are not the only ones who are unhappy. Exporters in the US claim the tariffs are costing jobs there. In March, the US President warned that he would suspend Rwanda’s tariff-free access to US markets for its clothing exports after 60 days if it did not remove the tariff. Globally, about $4 billion of used clothes crossed borders in 2016. The share from China and South Korea is growing, but 70% still come from Europe and North America. Many go to Asia and eastern Europe, but Africa remains the largest market. The trade enables poor people to afford clothes and creates retail jobs. However, governments worry that the trade undercuts their own clothing manufacturers. Second-hand imports of clothing now dominate African markets. Researchers at the Overseas Development Institute, a British think-tank, estimate that Tanzania imports 540 million used items of clothing and 180 million new ones each year, while producing fewer than 20 million itself. African manufacturing is weak for many reasons, from ineffective privatisations to collapsing infrastructure. But second-hand clothing imports are a major factor: it is estimated that they accounted for half of the fall in employment in the African clothing industry between 1981 and 2000. For example, a clothing factory in Kigali is operating at only 40% of capacity and employs 600 workers, down from 1100 in the 1990s. It is hard to compete, says Ritesh Patel, its manager, when a used imported T-shirt sells for the price of a bottle of water. Instead, the company specialises in uniforms for police, soldiers and security guards, which cannot be bought second-hand. The threatened suspension of tariff-free access to the US market would hurt Rwanda, but not very much. Last year Rwanda sold just $1.5 million of clothing to the US. Nor, with about 12 million people, is Rwanda a big market for US exports.

(Source adapted from: https://www.economist.com/finance-and-economics/2018/05/31/rwanda-refuses-to-remove-tariffs-on-imports-of-used-clothing)

Savings often provide the funds for investment. The UK's household savings ratio fell from 9.3% in 2015-16 to 5.3% in 2019-20. However, it surged to 16.9% in over the year 2020-21 as a result of the significant economic disruption caused by the global pandemic. 

Evaluate the likely impact of a rise in the saving ratio on the UK economy (25)

Against a backdrop of tightening monetary policy and slow economic growth, business investment had risen by 3.4% in 2023, which was stronger than expected. 

Evaluate the factors that might influence investment in an economy of your choice (25)