consumption

• The marginal propensity to consume is the change in consumer spending arising from a change in disposable income. For example, if disposable income increases by £5,000 and one chooses to spend 4,000 of this on extra goods and services, then the MPC is 0.8. MPC is generally higher for lower-income families.
• The marginal propensity to save is the change in saving as a result of changing disposable income. For example, if disposable income increases by £5,000 and £1,000 is saved, MPS is 0.2. MPC and MPS always add up to 1.
• Factors influencing the levels of consumer spending are:

  • changes in real disposable income (Yd)
  • availability and cost of consumer credit
  • cost of servicing a mortgage
  • expectations of future price changes
• Factors affecting the levels of consumer spending are:

  • changes in employment and job security
  • changes in asset prices, possible wealth effect
  • general state of consumer confidence ('animal spirits')
• The wealth effect is the idea that consumers spend more when their wealth increases, even if their income stays the same. For example, if the price of someone's house increases, they may feel wealthier and therefore spend more.
• A rise in interest rates will lead to a decrease in consumption and vice versa, both because it becomes more expensive to borrow money to spend and because higher mortgage payments will lead to less disposable income.
• If consumers expect their financial situation to be the same or better in the future, they will tend to maintain or increase their spending. If they expect their situation to become worse, however, because of inflation or a rise in unemployment (for example), consumer confidence deteriorates and consumption will decrease.
• Inflation can have two opposite effects on inflation. A rise in prices will decrease consumer confidence and cause consumption to decrease, but a rise in the value of their assets (such as their house or car) might make them feel more confident about spending. Additionally, if households know that prices will rise in the future, they might increase spending in the present to buy goods and services while they are cheaper.