CONSUMPTION

consumption is the spending on consumer goods and services over a period of time. for eg ; spending on phones

THERE ARE TWO WAYS OF CLASSIFYING CONSUMPTION :

• the spending on tangible / physical items and the spending on intangible items (services)

• durable goods; goods that are although bought at a point in time, continue to provide a stream of services over a period of time. non durable goods; goods that are used up immediately or provide services for a short period of time

SAVINGS :

savings refers to the part of disposable income that is not spent. in a two-sector economy with firms and households , any income that isnt spent is considered to be saved.

• saving is a flow concept that takes place over a period of time. it is added to a stock of savings fixed at a point in time

• whereas ‘savings’ is the accumulation of past savings

disposable income refers to the amount of income left to individuals after having paid direct taxes and receiving any transfer payments or benefits

FACTORS THAT AFFECT CONSUMPTION :

the relationship between consumption and factors that determine how much a household consumes is called the consumption factor

• disposable income: the most important determinant , suggested by the keynesian theory of consumption. typically , the higher the disposable income , the more money left to individuals to spend. however, we are also concerned with how much an increase in income affects consumption, this is called the marginal propensity to consume (MPC). for most people, MPC will be positive but less than 1 i.e. an increase in income increases spending but spending doesn’t increase by as much as income. some people will have an MPC of more than one as they use borrowing or savings to fulfil the demand for goods which is higher than their increase in income.

MPC is the proportion of a change in income that is spent on the consumption of goods and services

APC is a measure of the change in the amount spent on consumption out of total income.

Poorer people tend to have a higher MPC as they are likely to spend much more of

their increase in income whilst richer people are more likely to save it.

• interest rates: as interest rates rise , consumers have more incentive to save because they will receive greater return on savings so they prefer to save instead of spending. additionally , the cost of buying on credit will rise and other interest payments on any variable rates on loans already taken will rise so discretionary income will fall. also, a rise in interest rates decreases the value of shares and so people experience a negative wealth effect.

• consumer confidence: if consumers expect their financial situation to remain stable or even improve in the future , they will maintain or increase their spendings as they know that they will wont have to spend out of savings or such. but if they expect inflation in the future , they will cut out their spending on non essential items and purchase essential goods now as it is cheaper than it will be in the future. furthermore , if they’re going through recession or expect future unemployment , they will cut consumption and save more money for the future

• wealth effect: if the wealth ( physical or monetary ) of a household increases , consumption will also increase. The wealth effect is experienced when real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage. It can also be experienced when share prices rise as people may sell some of their shares and spend the money or may be more confident in spending the money they have as they know they have the shares to fall back on in case of financial difficulty ( wealth is defined as the total value of assets owned by an individual or household )

• the availability of credit: many goods are purchased on credit , so if banks and financial institutions make it more difficult for consumers to borrow then consumption is likely to fall and vice versa. if credit is provided abundantly, more consumers will increase their consumption as they may find it easier to purchase goods and pay at a later date when they have more money

• Inflation: inflation is the general and continuous rise in average price levels in an economy. if households expect prices to be higher in the future , they will be tempted to forward their purchases so the expectation of inflation can increase consumption , but during inflation the level of consumption will generally fall because the purchasing power of money falls, which means more money would be required to buy the same amount of goods. as a result , consumers will cut out on spending and save instead.

• the composition of households: younger people and older people spend a higher proportion of their income than those in the middle age. this is because younger people need to spend on setting up their homes and upbringing their children whereas older people are retired and arent earning any income , so they need to spend more to meet their needs. those in the middle age often build up their stock of savings for retirement

THE SAVINGS FUNCTION:

An increase in consumption decreases savings so the same factors which affect consumption are those which affect savings- but in the opposite way. For example, a rise in confidence will decrease savings

factors that affect consumption also affect savings, such as:

• disposable income

• the real interest rate on savings

• consumer confidence

• tax incentives

• age structure of population

• cultural and social factors

the APS is the proportion of total income which is saved