Consumption the amount households spend on goods & services “disposable income” is the income left over after direct taxation plus state benefits The tendency to spend an extra £1 earned is called the “marginal propensity to consume” (MPC) – if we spend £0.70 of each extra £1 we earn, MPC is 0.7 (the rest is saved )

A Simple 2-Sector Model (Firms and Households) Wages, Rent, Dividends (Income) Consumption Spending (Expenditure) Goods & Services (Value of Output) Labour, Land, Capital The UK economy - performance and policies

We don’t spend everything we receive… MPC – Marginal Propensity to Consume How much out of each extra £1 we earn do we spend? If I earn £1000 more this year and MPC is 0.7, how much of that do I spend? (the rest is saved) MPC = Δ C = Δ Consumption ΔY Δ Income What proportion of increased income results in increased consumption

Influences on Consumption Real Incomes Cost & Availability of Credit Wealth Influences on Consumption Confidence Direct Taxes Savings

Saving the disposable income which is not spent as income rises, both the nominal amount saved and the ‘marginal propensity to save’ tend to increase eg. a person with a disposable income of £1000/month may save £100 (10%) whereas a person with disposable income of £4000/month may save £1000 (35%)

Influences on Saving Real Incomes Interest Rates Gov’t Policies Culture & Attitudes

How much do we save? MPS – Marginal Propensity to Save MPS = Δ S = Δ Savings ΔY Δ Income Or… MPS = 1 - MPC

Saving vs. Savings Flow versus Stock Remember income versus wealth? ‘Saving’ is the amount not spent ‘Savings’ is the total accumulated pot of money that has not been spent

A little something extra to think about: The Paradox of Thrift According to Keynes, although saving is required for long term growth (investment), planned saving can in fact lead to a decrease in investment. The immediate effect of an increased desire to save is a fall in consumption. This reduces the incomes of producers. This could lead to a fall in national income, decreasing the amount available to save & thus invest.

MPC and APC How much of a household’s income is spent is called the average propensity to consume APC = The marginal propensity to consume measures the proportion of an increase in income that is spent MPC = Consumption Income Change in consumption Change in income The blue line represents consumption if all income is spent The red line is actual consumption, showing that with no income, households still spend some money, drawing down on saving or borrowing The slope of the red line is the marginal propensity to consume, g/h, or b which shows as income increases, so does consumption, but not by as much

Example Income (Y) Consumption (C) Saving (S) 50 60 -10 100 95 5 150 125 25 200 250 170 80 300 185 115 What is the MPC as income rises from 150 to 200? How about 250 and 300? What is the APC at an income of 200 and 300? All else equal (ceteris paribus), as income increases both consumption and saving increase The higher the income, the lower the APC (those on higher incomes can afford to save) The MPC may also fall as incomes rise