Consumption is spending by households on goods & services
In 2012 consumer spending in the UK was £927 billion out of a total GDP level of £1504 billion
Consumption is the biggest single component of aggregate demand, in 2012 it was 61% of GDP
Many factors affect the ability of people to spend and this has a large effect on the economic cycle
Disposable income and spending – the propensity to spend
John Maynard Keynes was undoubtedly one of the major figures in the history of economics developed a theory of consumption that depended mainly on disposable income. Disposable income is income after direct taxes and welfare benefits.
The Propensity to Consume
What matters is the rate at which consumers increase their spending as income rises. This is called the marginal propensity to consume. Say that someone receives extra pay of £2000 in a year and they spend £1500, thus the marginal propensity to consume is £1500 / £2000 = 0.75. The remainder is saved so the marginal propensity to save is 0.25.
A simple rule to remember is that the marginal propensity to consumer added to the marginal propensity to save must always equal 1.
Generally, people on lower incomes tend to have a higher propensity to spend. This matters when the government announces changes in taxation and the level of welfare benefits. A fall in the marginal propensity to spend will cause a lower level of consumption for a given level of income.
Some Factors that Determine Consumer Spending
Many factors have an influence on the total level of consumer spending in an economy.
Consumer confidence is measured using surveys that ask people about their own financial situation and expectations for themselves and the economy. When consumer confidence is low people save more because of fears about job security and future income.
The Wealth Effect
Most of us at some time in our lives need to borrow money to finance spending. The credit market for individuals is complex. Broadly speaking we can distinguish between:
One of the most important features of the British economy in recent years has been the high levels of borrowing. To use a technical term, what we have seen is a ‘leveraging up’ of the consumer sector – people seem to have been happy to increase the ratio of their debt to income with the result that the UK still has one of the highest debt-to-income ratios of any of the leading economies.