10.2 Nonincome Determinants of Consumption and Saving

What are the main nonincome determinants of consumption?

Wealth; borrowing; expectations about future income and prices; real interest rates.

How does wealth affect consumption?

Higher wealth raises present and future consumption possibilities, shifting the consumption schedule up and the saving schedule down.

What is the “wealth effect”?

When asset values rise (stocks, homes), households feel richer and spend more; the consumption schedule shifts upward.

What happened to consumption after the 2008 wealth decline?

Falling asset values erased trillions in wealth, households cut consumption, and the consumption schedule shifted downward.

How does borrowing affect current consumption?

Borrowing allows households to increase current consumption above DI, shifting the current consumption schedule upward.

What is the future cost of increased borrowing today?

Borrowing raises liabilities, reduces future wealth, and requires lower future consumption to repay debt.

How do expectations about future income or prices influence consumption?

Expectation of higher future prices raises current consumption; expectation of lower future income (recession) raises current saving and lowers consumption.

How do real interest rates affect consumption and saving?

Lower real rates make borrowing cheaper and saving less attractive, modestly raising consumption (especially credit-financed goods) and lowering saving; higher rates do the opposite.

Are interest-rate effects large or small on overall consumption?

Effects are generally modest and often shift spending toward creditable goods rather than causing large overall changes.

What does it mean to shift the consumption schedule versus move along it?

A movement along the schedule is caused by a change in real GDP (or DI); a shift of the entire schedule is caused by nonincome determinants (wealth, borrowing, expectations, interest rates, taxes).

How do consumption and saving schedules move relative to each other when nonincome determinants change?

They move oppositely: an upward shift in consumption implies a downward shift in saving and vice versa.

How do taxes affect the consumption and saving schedules?

A tax increase reduces both consumption and saving (both schedules shift down); a tax cut increases both consumption and saving (both shift up).

What is dissaving and when does it occur?

Dissaving is consuming more than disposable income (C > DI), financed by borrowing or selling assets; shown when the consumption schedule is above the 45° line.

What is “borrowing is negative saving”?

Borrowing raises current consumption without increasing current saving; it is effectively reducing current saving because it increases liabilities.

Why do consumption and saving schedules tend to be stable?

Long-term considerations (emergency funds, retirement), and offsetting effects among nonincome determinants make the schedules relatively stable except for big shocks or major tax changes.

Why do economists switch to real GDP on the horizontal axis?

Real GDP adjusts for inflation and reflects actual output, so it better links consumption/saving decisions to the economy’s real production.

What is the graphical indicator of saving on the consumption vs. real GDP graph?

The vertical distance between the 45° line and the consumption schedule at a given real GDP equals saving (S = DI − C).

What happens to production and employment if planned buying is less than output?

Inventories build, firms cut production, lay off workers, and the economy moves toward recession.

How do simultaneous shifts work when households decide to consume more at each level of real GDP?

Consumption schedule shifts up and the saving schedule shifts down; if they consume less at each level, consumption shifts down and saving shifts up.

Give a quick rule summarizing nonincome determinants’ effects.

Anything that raises households’ perceived ability to spend (higher wealth, more borrowing, optimism, lower real rates) shifts consumption up and saving down; the opposite changes shift consumption down and saving up.