2.2.2 Consumption

• Consumer spending


  How much consumers spend on goods and services
• Consumer spending is the largest component of AD and is therefore most significant to economic growth
• Consumer spending makes up just over 60% of GDP
• Disposable income


  The amount of income consumers have left over after taxes and social security charges have been removed
• Sources of consumer income

  • Wages
  • Savings
  • Pensions
  • Benefits
  • Investments, such as dividend payments
• Marginal propensity to consume


  How much a consumer changes their spending following a change in income
• Keynes developed a theory of consumption and its link to disposable income
• Consumers on low incomes are more likely to spend
• Marginal propensity to save


  The proportion of each additional pound of household income that is used for saving
• A consumer's marginal propensity to consume added to the marginal propensity to save is equal to 1
• Consumer income which is not spent is saved
• Influences on consumer spending

  • Interest rates
  • Consumer confidence
  • Wealth effects
• How interest rates influence consumer spending

  1. Monetary Policy Committee lowers interest rates

  2. Cheaper to borrow and reduces incentive to save

  3. Spending and investment increase

  4. Time lags between change in interest rates and rise in AD
• How interest rates influence consumer spending


  1. Lower interest rates lower cost of debt, such as mortgages

  2. Increases effective disposable income of households
• Consumer confidence


  Consumers and firms have higher confidence levels, so they invest and spend more, because they feel as though they will get a higher return on them
• Consumer confidence


  Affected by anticipated income and inflation
• If consumers fear unemployment or higher taxes


  Consumers may feel less confident about the economy, so they are likely to spend less and save more
• Wealth effect


  A rise in the price of houses makes people feel wealthier, so they are likely to spend more
• Housing equity


  The difference between the market value of a property and how much loan is remaining to be paid
• If house prices increase

  Consumers experience a rise in equity, so they might be paying less on their mortgage than the house is worth on the market, making them feel wealthier and more willing to spend