2.2.2 Consumption

a) Disposable Income and Its Influence on Consumer Spending:

Disposable income

is the income left over for an individual or household after taxes have been paid. It is a crucial determinant of consumer spending.

Relationship Between Disposable Income and Consumer Spending:

Generally, as disposable income increases, consumer spending tends to rise.

This relationship is explained by the marginal propensity to consume (MPC), which is the proportion of an additional dollar of income that a consumer spends.

If MPC is 0.8, it means that for every additional dollar of disposable income, the consumer will spend 80 cents and save 20 cents.

Real-World Example:

During an economic downturn, people may experience a decrease in disposable income due to job losses. This can lead to a reduction in consumer spending, negatively impacting businesses.

b) Understanding the Relationship Between Savings and Consumption:

Savings

The portion of income that is not spent on consumption. There is an inverse relationship between savings and consumption:

When consumers save more (increase savings), they spend less on consumption.

When consumers save less (decrease savings), they spend more on consumption.

Real-World Example:

During economic booms, people often feel more financially secure and may reduce their savings rate, leading to increased consumer spending on items like luxury goods, travel, and dining out.

c) Other Influences on Consumer Spending:

i. Interest Rates:

Lower interest rates tend to stimulate consumer spending because borrowing costs are reduced.

For example, when mortgage interest rates are low, more people may buy homes, leading to increased spending on furniture and home-related goods.

ii. Consumer Confidence:

Consumer confidence reflects the optimism or pessimism of consumers about the future of the economy.

Higher consumer confidence generally leads to increased consumer spending, as people are more willing to make major purchases when they believe the economy is doing well.

iii. Wealth Effects:

When the value of assets such as homes or stocks increases, consumers tend to feel wealthier and spend more.

Conversely, during a financial crisis, declining asset values can lead to reduced consumer spending.