Consumption and Saving

Consumption:  Spending to satisfy needs and wants.

People buying food

Happy Man Buying Car

 Kim Kardashian and her mom were shopping in Paris and spent $100,000 on handbags at Hermes. Seven of them, including six Birkins and a super rare crocodile skin purse that cost about $30,000 on its own.

Factors affecting consumption  1. Very obvious – income – the higher the income the higher the consumption.

Income  The money received for goods, services or labour, or from other sources, as rent or investments.

 Do unemployed people have an income?

Both Tim and Jim live in California. TimY = $14,000 a year  Lives in a rented apartment with 4 others.  Bus to work.  Eats three meals a day, but is sick of frozen foods. Would like to taste more high quality meat.  Would like to do a night course but cannot afford it.  Has not been on a holiday in 4 years. Jim Y = $380,000 a year  Lives in his seven bedroom house in California. Also owns a holiday home in Lake Tahoe and an apartment in Seattle.  Drives his Porche to work, uses his SUV for weekend trips.  Enjoys visiting the best restaurants in LA.  Usually goes on 2-3 foreign holidays a year. Most recently to Peru.

 Both Tim and Jim get a pay increase of 10%.  That brings their income up to….

 Both Tim and Jim get a pay increase of 10%.  That brings their income up to  Tim:$15,400  Jim:$418,000

 At low incomes, people will spend a high proportion of any additional income.  When you have low income, you don’t have the luxury of being able to save. You need to spend everything you have on essentials.

 However, as incomes rise, people can afford the luxury of saving a higher proportion of their income. Therefore, as income rise, spending increases at a lower rate than disposable income. People with high incomes have a lower average propensity to spend.

 The Marginal Propensity to Consume.  The Marginal Propensity to Consume is the % of extra income that will be spent.  The Marginal Propensity to Save  The Marginal Propensity to Save is the % of extra income which is saved.

So, in light of this:  A tax cut for the wealthiest people has the impact of increasing their disposable income by $2bn.  A NMW increase has the impact of increasing NMW earners’ disposable income by $2bn.

Apart from income, what else determines how much we consume?  Wealth

Wealth versus Income  Wealth is not the same as income.  Wealth:  A measure of the value of all of the assets owned by a person

Wealth Effect  The wealth effect is the change in spending following a change in wealth.  This change in wealth can be real or imagined.  season-6-episode-17-homer-vs-patty-and- selma/ season-6-episode-17-homer-vs-patty-and- selma/

What might affect the wealth effect?  1. Changing house prices.  2. Changing share values.

Apart from income, what else determines how much we consume?  Inflation

Apart from income, what else determines how much we consume?  Interest rates, particularly for bigger purchases.

Apart from income, what else determines how much we consume?  The willingness banks have to lend. (The avaîlability of credit)

Apart from income, what else determines how much we consume?  Expectations….. Feel good factor

Positive Net Migration

Apart from income, what else determines how much we consume?  Age profile of the households

JM Keynes  British economist…what did he say about consumption?

Keynes`s views  Income most important, moreso than wealth or interest rates.  He also believed people with higher incomes had a lower MPC than those with lower incomes

 Marginal Propensity to Consume versus the Marginal Propensity to Save

Would the following have an effect on the MPC or the MPS?  A rising unemployment rate  The 9-11 attacks  The Bank of England reducing interest rates  Cautious banks reluctant to issue credit cards

Would the following have an effect on the MPC or the MPS?  Falling house prices  Rising index of share prices  A new emerging, middle class  A higher rate of VAT  Inflation reaching 5.6%  Good weather

Milton Friedman`s views  He placed greater emphasis on wealth than Keynes had done

Franco Modigliani and Albert Ando  People`s future expectations are important. Those who feel that they will have higher incomes in the future, don`t bother to save now.