Consumption
Economics: Edexcel A A Level, topic 3.2.2
Disposable Income, Savings and Investment
Disposable income is the amount of money that people have left after paying their income taxes. Saving is the part of disposable income that is not spent on things like food, clothing and rent.
Disposable income
- Disposable income is the amount of money that people have left after paying their income taxes.
- An increase in disposable income will lead to an increase in consumer spending unless consumers save all of this rise (which they almost never do).
- Research in the USA found that a large proportion of the 2001 Bush tax cuts was spent by consumers, rather than saved.
Savings
- Savings is the part of disposable income that is not spent.
- The savings ratio is the ratio of savings to income (S/Y).
- Lots of economic models assume that investment is equal to savings. When you save money in a bank account or buy stocks, this money is then invested by banks or corporates.
- If the savings ratio rises, it is likely that consumption will fall. This is because: savings + consumption = disposable income.
Determinants of consumer spending
- The interest rate (return) being received on savings. If the interest rate rises, then saving is more attractive, so consumers will spend less and save more.
- The level of consumer confidence in the future. If confidence is low, consumers will spend less and save more.
- Wealth effects happen if asset prices rise and consumers feel as though they have more money. They may spend more if share prices or property prices rise.
- Inflation expectations (if prices are going to rise in the future, people may spend now and save less now).
- Level of income (people with higher incomes tend to save more – they have a higher marginal propensity to save, that is for every extra pound people get, they save more as they get richer).
Investment
- Investment is any expenditure that increases the capital stock of a country.
- Banks recycle savings in bank accounts and lend to companies. This allows them to invest in long-term projects.
- Gross investment is the total amount that companies spend on investment.
- Net investment is the gross investment - depreciation. Depreciation is the deterioration of assets over time. Cars don't last forever and depreciate gradually until they are useless and have no value.
Test yourself on Consumption
Why do similar things affect the saving & consumption behaviour?