Chapter 17: Households

• Disposable income: the amount of income a person has available to spend on goods and services after compulsory deductions such as income tax
• Main source of income: wages/salaries
• Other sources of income:

  • Interest on savings (return on capital)
  • Rent earned from leasing property (return on land)
  • Dividends/return on enterprise (a share of a company’s profits from shares owned in a company)
  • Profit earned from running a business (return on enterprise).
• Current expenditure: money spent on goods and services consumed within the current year
• Capital expenditure: money spent on fixed assets (items owned by an individual or firm which last more than 12 months)
• Impact of household income on spending, saving, and borrowing:

  
• Positive wealth effect: when the value of assets, such as property and other investments, increases, which causes owners of assets to borrow against the value of the existing asset, such as residential or commercial property
• Conspicuous consumption: occurs when (usually already wealthy) people purchase goods and services that they feel increase their status or image
• How do interest rates affect the level of spending, saving and borrowing?

  • Interest rate increases -> consumer spending decreases -> borrowing decreases -> saving increases
  • Interest repayments of loans and mortgages increases, so individuals who have to pay for them save more money and spend less
  • Savings may become more attractive due to the higher return
• How do confidence levels affect the level of spending, saving and borrowing?

  • During a recession, people are unsure of the economy's future, so they choose to spend less and save more to prepare for the worst possible outcome, like losing their job
  • During an economic boom or a period of high economic growth, people and firms are confident about the future, so they purchase more luxury items or invest in new equipment and technology, increasing spending and borrowing.
• How does inflation affect the level of spending, saving and borrowing?

  • Prices in the economy increases -> consumers' purchasing power decreases
  • Inflation -> spending decreases -> saving decreases + borrowing increases
• How does age affect the level of spending, saving and borrowing?

  • Young: usually have low income -> spend only on necessities
  • Older: earnings increases -> saving increases for future (marriage and children)
  • Family stage: spend on children + save for children's future (ex: university) and pension for retirement -> dissave (opposite of saving) + spend from saving
• How does household size affect the level of spending, saving and borrowing?

  • Household size increase -> need to consumer more goods and services -> spending increases
• Saving: occurs when a person puts away part of their current income for future spendings
• Reasons for saving: funds for future, earn interest, have emergency funds
• How do income levels affect levels of saving?

  • Generally: income increases -> savings increases
  • Wealthy: more able to save a higher proportion of each extra dollar earned
• What are the variety of attitudes towards saving?

  • US & UK: use credit cards to fund expenditures or get loans to buy expensive items -> save less
  • China: conservative -> really cautious with money to save for a 'rainy day' (unforeseen circumstances)
  • Others (ex: Japan & Germany): use of credit cards low -> save more
• Borrowing: occurs when an individual, firm, or the government takes out a loan from a bank or financial institution, paying it back to the financial lender over some time, with interest payments
• Purpose of borrowing:

  • Fund expensive items
  • Fund private and tertiary education
  • Purchase property or land, such as a factory, office or home
  • Start up a new business
  • Fund large projects, such as business expansion in a foreign country
• What are other factors that affect the level of borrowing?

  • Availability of funds: the central bank controls the cash reserve ratio
  • Credit cards: if only a portion is repaid, interest is charged on the remainder
  • Store cards: can give incentives to overcharge and increase debt + if only a portion is repaid, interest is charged on the remainder
  • Wealth: bank more willing to lend to wealthy, as there is a higher guarantee they'll repay
• Analyse the impact of a cut in interest rates on saving and investment:

  • Saving is expected to fall as the return from saving falls, reducing the opportunity cost of spending, causing individuals to spend more and borrow more.
  • Investment will rise as it becomes cheaper for firms to borrow, reducing the cost of investment and making investment more profitable.