Chapter 3 Summary: Expenditure and Budgeting

Chapter 3: Expenditure

Introduction

This chapter focuses on spending (expenditure) as one of the two primary uses of disposable income, the other being saving. Choices regarding spending are critical for achieving financial security and goals. Overspending leads to debt, while underspending allows for saving or debt repayment. The chapter explores the determinants of individual and household expenditure in a consumer society where spending is both necessary and a leisure activity. Consumer society is defined as a society where people place a high value on possessions and are continually encouraged to buy more.

The chapter covers economic and social influences on spending, introduces budgeting as a means to improve household finances, and discusses the complexities of financial management in multi-person households, including those with children.

Economic Influences on Spending

This section examines how economic factors like income, price level, and relative prices affect household expenditure. It also considers the impact of household consumption on the economy as a whole.

Household Consumption and the Economy

Household consumption, the total spending on goods and services by all households in a country, is a major driver of economic growth, contributing significantly to a country's gross domestic product (GDP). Figure 3.1 illustrates household consumption as a percentage of GDP in selected countries from 1990-2022. Activity 3.1 highlights the stable proportion of household consumption in GDP in most countries, with India and the UK as exceptions, and the variation in this proportion across countries.

The level of household consumption as a proportion of GDP varies greatly between countries due to differences in government spending. Sweden, with higher government spending, has a lower percentage of household consumption in GDP compared to the US, where government spending is lower. Figure 3.2 breaks down household consumption by type of spending, showing that the US spends a higher proportion on health and social protection, insurance and financial services compared to Sweden. India spends a higher proportion on food and drink.

Household Spending and Income

As income rises, the proportion spent on necessities like food decreases, while spending on leisure goods and services increases. Spending on certain goods, such as tobacco, may decrease as people adopt healthier lifestyles.

Household Spending and the Price Level

Inflation, which reduces purchasing power, can have conflicting effects on household spending. Households may cut spending or switch to cheaper substitutes. However, the 'lipstick effect' suggests that during economic downturns, spending on smaller, affordable treats may increase. Expectations of rising prices may also lead households to bring forward major purchases. Conversely, deflation may cause consumers to postpone spending in anticipation of lower prices.

Household Spending and Relative Prices

Variations in the price of different goods and services can drive changes in consumption patterns. Lower prices may lead to increased consumption, but not always, as demonstrated by the example of petrol.

Social Influences on Consumption

This section explores how social pressures and marketing shape spending decisions. It encourages reflection on personal spending behavior in relation to these theories.

Consumption as Status and Identity

Social status, a person's position in society based on authority and prestige, influences spending decisions. In consumer societies, consumption has replaced work as a source of status and identity. Bauman (1999) argues that consumption is essential for establishing identity and belonging in a consumer society. This creates pressure to keep up with trends.

Displays of Status

Status symbols, used to publicly display status, have evolved from traditional body marks and clothing to consumer goods. Symbolic consumption reflects concern about others' opinions and gives a powerful motivation for spending. Veblen (1925) saw spending as a way of displaying wealth, with expensive products bought for their symbolic value rather than their function. Conspicuous consumption, the ostentatious display of wealth, is used to gain recognition of high status. This can lead to debt for those on lower incomes.

Signs of Belonging

Bourdieu (1977) argues that consumption is used to distinguish people by social class. Tastes are influenced by childhood, family, schooling, and social class. Consumption signals belonging to social groups, with tastes shaped by the desire to belong to a specific class.

Changing with the Times

Status symbols change over time. Conspicuous consumption of time, or ‘busyness’ at work, has become a status symbol. There is also a shift towards inconspicuous consumption, reflecting cultural standing rather than material ownership. Wealthy consumers are shifting towards distinguishing themselves through more subtle, less obvious branding.

Marketing and Advertising

Marketing and advertising use symbolism to sell products. Klein (2000) suggests that marketing departments focus on brands' deep inner meanings to capture the spirit of individuality or community. Marketers target consumers relentlessly, using online adverts tailored to browsing history and loyalty cards to gather data. Segmentation of the population into socio-demographic groups is used to target products effectively.

Marketing can be viewed as providing information for informed consumer choices or as creating wants and perceived needs. Galbraith (1958) argued that marketing makes consumers want the things that producers make. Behavioral biases make consumers susceptible to marketing tactics.

Budgeting

Budgeting helps reconcile the pressures to consume with the need to save and invest. It involves actively controlling and planning household income and expenditure.

The Budgeting Process

Budgeting manages finances and is most effective when carried out regularly. It estimates income and expenditure over a future time period, helping to control spending, ensure future spending can be met, and enable planning to meet goals. The process begins with a cash flow statement, recording current sources of disposable income and current expenditure.

A spending diary can help track spending habits. Expenditure is classified under different headings on the cash flow statement. Irregular income and spending need to be converted into average amounts for the chosen time period. Table 3.1 shows Shivani's cash flow statement and budget.

Patterns of Spending

Budgeting involves identifying essential and non-essential spending. Essential spending avoids negative outcomes, while non-essential spending is influenced by social pressures. Social norms change over time, with items like mobile phones and internet access now considered essential for participating in contemporary society.

Box 3.2 provides tips to help make ends meet, such as shopping around for utilities, using price comparison websites, and cutting down on eating out. Price is often used as a mental shortcut to assess quality, although this is not always accurate. Heuristics, rules of thumb used to assess situations, can also influence spending.

Budgeting and the Life Course

Spending is influenced by life stage. Figure 3.5 shows the income and expenditure profile for an individual, Dan, over his life course. Anticipating changes in income and expenditure is key to financial planning. Budgeting helps control spending and frees up resources for planning ahead.

Managing Money in Multi-Person Households

This section examines financial issues that arise when living with others, particularly the budgetary implications of being part of a couple and having children.

Economies of Scale in Consumption

Living with others can be cheaper due to economies of scale in consumption, where costs are spread across more people. Economies of scale arise from public good elements, bulk-buying, and efficient use of goods and services. Household equivalence scales are used to calculate the effects of household size on standards of living.

The Impact of Children on Budgeting and Financial Planning

The arrival of a baby alters expenditure and may affect income. Figure 3.6 illustrates the potential impact of having a child on cash flow. Budgeting is highly relevant in situations such as planning and having a family. Using the equivalence scale estimates the impact on the household's standard of living.

Couples and Managing Money

Couples face decisions about how to manage money, influenced by social norms. Box 3.4 describes systems of managing household finances. Pahl (2000) suggests there is a difference between the management and control of money. Disagreements over money are a common reason for arguments, and planning a budget and agreeing a system of money management can help avoid tensions.

Conclusion

This chapter covered economic and social influences on spending, as well as budgeting as a crucial component of financial planning. It explored the interrelationship between individuals and households and highlighted the financial advantages and challenges of living together.