Consumers and Business Notes

Consumers and Business

The Role of Consumers in the Economy

Focus: How consumers and businesses make decisions, driven by self-interest in a market economy.
Consumer Sovereignty: The idea that consumers determine what and how much is produced, thus directing resource allocation in the economy.
Patterns of Consumer Spending and Saving/Dissaving:
- Variations based on income and age.
- Individuals either spend or save income.
- As income rises, saving levels increase.
Factors Influencing Individual Consumer Choice:
- Income
- Price
- Price of substitutes
- Price of complements
- Preferences/tastes
- Advertising

Sources of Income

Return for resources: wages, rent, interest, and profits.
Social welfare.

The Role of Business in the Economy

Definition of a Firm and an Industry
A Firm’s Production Decisions:
- What to produce
- What quantities to produce
- How to produce
Business as a Source of Economic Growth:
- Increased productive capacity.
Goals of the Firm:
- Maximising profits
- Maximising growth
- Increasing market share
- Meeting shareholder expectations
- Satisficing

Efficiency and the Production Process

Productivity.
Internal and external economies of scale.
Diseconomies of scale.
Impact of Investment, Technological Change, and Ethical Decision-Making on a Firm:
- Production methods
- Prices
- Employment
- Output
- Profits
- Types of products
- Globalisation
- Environmental sustainability

Economic Issues

Examine the impact of income on spending and saving decisions of individuals.
Assess the extent to which consumer sovereignty is achieved in various markets.
Investigate the relative significance of various income sources in Australia.
Investigate factors leading to change in a particular industry.

Economic Skills

Analyse the impact of changes in consumer income levels on the types of production within the economy.
Explain the role of firms in solving the economic problem.

Consumer Sovereignty in Detail

Definition: Consumer sovereignty is a theory that suggests consumers determine WHAT is produced and HOW MUCH is produced.
Determines how resources are allocated in the economy.

Business Influence on Consumer Spending

Marketing.
Misleading or deceptive conduct.
Planned obsolescence.
Anti-competitive behaviour.
Examples with Apple products.

Factors Affecting Saving and Spending Decisions

Options for using after-tax income: Consumption (C) or Savings (S).
Factors:
- Personality (cautious vs. optimistic).
- Cultural factors (saving tendencies).
- Future expectations (promotion, unemployment).
- Specific plans (house, car, holiday).
- Tax policies.
- Credit availability.
- Age.
Most Significant Factors: Income and Age.

Changes in Income and Behavior

Economists study behavior when incomes change.
Do we increase spending, savings, or both?
Why do we save a greater proportion of our income when our income increases?

Influence of Age

A person’s income is not always constant over their lifetime.
Income is highest at a certain point in life.
Income changes upon retirement.
This impacts consumption expenditure.

Equation for Saving and Spending

$Income = Consumption + Savings$
$Y = C + S$
What happens if consumption rises? Savings rise? Income increases?

Average Propensity to Consume (APC)

Definition: Measures the proportion of income that is spent rather than saved.
Synonyms for ‘proportion’: percentage, share.
Formula: $APC = \frac{Consumption}{Income} = \frac{C}{Y}$

Average Propensity to Save (APS)

Definition: Measures the proportion of income that is saved rather than spent.
Formula: $APS = \frac{Saving}{Income} = \frac{S}{Y}$

Household Savings Ratio

Comparisons between Australia, China and USA.

Marginal Propensity to Consume (MPC)

Calculates what proportion of each extra dollar earned is spent on consumption.
It’s about the CHANGE in our consumption based on a CHANGE in our income.
Formula: $Marginal Propensity to Consume = \frac{Change \ in \ Consumption}{Change \ in \ Income} = \frac{C}{Y}$

Marginal Propensity to Save (MPS)

Calculates what proportion of each extra dollar earned is saved.
It’s about the CHANGE in our savings based on a CHANGE in our income.
Formula: $Marginal \ Propensity \ to \ Save = \frac{Change \ in \ Saving}{Change \ in \ Income} = \frac{S}{Y}$

Relationship between MPC and MPS

MPC and MPS at a particular change in income will always add to ONE (1).
$MPC + MPS = 1$

The Consumption Function

As income increases, so does consumption.
Even when income is $0, there is still some consumption expenditure (Cost of Survival).

The Multiplier Effect

The multiplier effect occurs when an initial injection into the circular flow causes a bigger final increase in GDP.
Formula: $Multiplier (K) = \frac{1}{MPS} \ \ OR \ \ \frac{1}{1 - MPC}$

Gross Domestic Product (GDP)

GDP is the total value of the final goods and services produced within an economy in a year.
An increase in GDP indicates economic growth.

Circular Flow Model

Leakages: Savings (S), Taxation (T), Imports (M).
Injections: Investment (I), Government Expenditure (G), Exports (X).
C = Consumption, Y = Income.

Aggregate Demand

If we add together the TOTAL of ALL of the demand for goods and services in a economy, we end up with AGGREGATE DEMAND

Formula for GDP or Aggregate Demand

$GDP/Agg \ D = C + I + G + (X - M)$
An increase in any one of these flows will increase GDP.

The Multiplier in Detail

$G \rightarrow C \rightarrow GDP$
The size of the second round of spending is determined by the multiplier effect.

The Multiplier Formula

$K = \frac{1}{MPS}$
If the government injects $2b into the economy (↑G), what will be the ultimate change in GDP?</li> <li>Answer:$ 2b x 2.5 = $5b $</li> <li>$ GDP/Agg \ D = C + I + G + (X - M) $</li> <li>Notice when the MPS is lower, the multiplier is higher</li> </ul> <h4 id="calculatingthemultiplierwithmpc">Calculating the Multiplier with MPC</h4> <ul> <li>We know that$ MPC + MPS = 1 $</li> <li>Therefore:$ K = \frac{1}{1 - MPC}$$