2.2.2 - Consumption

• Consumption is spending on consumer goods and services over a period of time
• Disposable income is the money consumers have left to spend , after taxes have been taken away and any state benefits have been added
• 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.
• Savings are 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.
• 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.
• Other Influences on Consumer Spending:

  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.
• Other Influences on Consumer Spending:

  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.
•  During the housing market bubble in the mid-2000s, rising home prices made many homeowners feel wealthier. This increase in perceived wealth contributed to higher consumer spending on items like home improvements and luxury goods.