Consumption. Consumption is total consumer expenditure on durables, non-durables and services.
An Increase in Consumption
An increase in consumption will increase AD and shift AD right.
Factors that Affect Consumption
Many factors could increase consumption:
- Real Disposable Income. A rise in real disposable income means consumers have more income to spend so they buy more goods.
- Direct Taxes. A fall in direct taxes increases consumers’ real disposable income so consumption rises.
- Confidence/Expectations. As consumers become more confident about the economy (and their own future income) they buy more goods so consumption rises.
- Interest Rate. A fall in interest rates means the cost of borrowing falls so consumers take out more loans and buy more goods (especially credit-bought items like T.V.s and home appliances). Moreover, the return on savings falls so saving becomes less attractive and consumption becomes more attractive. Furthermore, a fall in interest rates lowers mortgage repayments, consumers’ debt falls, real disposable income rises and consumption rises.
- Assets. As house prices rise, homeowners’ wealth rises inducing a wealth effect. Because consumers feel wealthier they will buy more goods and services so consumption rises. Also, a homeowner can borrow more against the higher value of their home and increase consumption (equity withdrawal).
Marginal Propensity to Consume and the Margional Propensity to Save
As consumers earn more income they may increase their consumption and/or saving. The marginal propensity to consume (MPC) measures how much each additional £ of income is used for consumption. If the MPC is 0.9: As income rises by £1, consumption rises by £0.90. The marginal propensity to save (MPS) measures how much each additional £ of income is saved. If the MPS is 0.1: As income rises by £1, savings rise by £0.10.