Consumption savings and investment Learning outcome X n

Consumption, savings and investment Learning outcome X n Define, consumption, savings and investment n Explain the determinants of consumption, saving and investment n Explain the difference between gross and net investment Reading: Units 31 & 32 A Leader in International Education in China

Consumption Spending on goods and services over a period of time

Saving Income which is not spent

Consumption and saving There are two calculations that can be made to better understand the rate of consumption/saving in an economy, they are: Ø average propensity to consume (APC) Ø marginal propensity to consume (MPC) n A Leader in International Education in China

Consumption and saving n APC = consumption income = n MPC = change in consumption = change in income A Leader in International Education in China C Y ∆C ∆Y

Consumption and saving (example) n n Total disposable income in an economy is $100 billion and consumption is $80 billion APC = C/Y = 80/100 = 0. 8 In the following year total disposable income increases to $110 billion and consumption increases to $85 billion MPC = ∆C/∆Y = 5/10 = 0. 5 A Leader in International Education in China

Determinants of consumption and saving Wealth n If the wealth of a household increases their consumption will increase, this is known as the wealth effect n Two of the main ways that wealth can increase in a short period of time are: Ø Increase in house prices Ø Increase in the stock market (shares) A Leader in International Education in China

Determinants of consumption and saving Inflation n Inflation effects consumption in two ways Ø If households expect higher prices in the future they will bring forward their purchases i. e. households expect car prices to increase in the coming months they will buy their cars now Ø Inflation tends to erode wealth i. e. the real value of money saved in the bank will decrease with inflation n These two effects have opposite effects on consumption A Leader in International Education in China

Determinants of consumption and saving Interest rates n Households borrow money to pay for consumer durables such as cars, furniture, house decoration etc n An increase in the interest rate will increase the cost of borrowing and so consumers will buy fewer consumer durables n Consumers also borrow money to buy a home n An increase in the interest rate will raise the cost of mortgages and so consumers will have less disposable income to spend A Leader in International Education in China

Determinants of consumption and saving Availability of credit n Governments may place restrictions on the availability of credit i. e. limits on amounts that can be borrowed or limit the number of loans available n When such restrictions are lifted households can increase their borrowing and so increase consumption A Leader in International Education in China

Determinants of consumption and saving Expectations n When consumers have a positive view of the future economy they are more likely to spend money and therefore consumption increases n When consumers have a negative view of the future economy they are less likely to spend money and therefore consumption decreases n This is often referred to as consumer confidence A Leader in International Education in China

Determinants of consumption and saving Unemployment n A decrease in unemployment will lead to an increase in consumption Taxation n Decreases in taxation will lead to an increase in consumption Technological development n Technology creates new products which motivates consumers to spend and so increases consumption i. e. mobile phones, DVD players and flat-screen televisions A Leader in International Education in China