Factors influencing household consumption Q7 - Estate Agent's Examination Part 1&2

Q.
Explain how these factors influence the household consumption.

a) Disposable income levels (5 marks)

b) Interest rate and loan conditions (5 marks)

c) Expected price of the future (5 marks)

d) Creation of new product (5 marks)

(20 marks, 2017 Q7)

A.
a) Disposable income levels

Positive - more disposable income means more available spending on household items. If a family has more disposable income, it could be spent in more quality of life items like electrical appliances, insurance, education and food staff.

Factor # 1. The Level of Income and its Distribution:
Consumption depends largely on income. The higher the income of an individual the more it is likely to spend on consumption. All other things being the same, people with high incomes would normally spend more of consumption goods than people with low incomes.

Since income is inequitably distributed in most non-socialist countries different income groups have different marginal propensities to consume (MPCs). In general the MPC of lower income groups tends to be much higher than that of the richer income group. What this means is lower income group might have no choice but to spend 100% of their entire income, whereas the richer person might have some savings and thus the MPC is less than 100%. In this regards, the increase in the household income may influence the lower income group to spend more than the 100% previously allowable due to necessity. Hence, the gain in income will give rise to increase spending.

Take for example, in a city 50% of the population are having MPC of 100% and the rest of the population at 80% MPC. Now, as the richer 50% of the population who have savings of 20% of their income, now employ maids instead of self cleaning the house. They spend the 10% of this savings to pay their maids, that means this 10% income will add on to the 50% poorer income group. In the new income distribution, the poorer group becomes richer. The gains will still be spent for buying necessities as their MPC is likely still 100%.

As a whole, the economy in this city is now seeing higher spending. The original 10% of saving is now spent and the MPC of this richer group now becomes 90%. Thus a redistribution of income from the rich to the poor is likely to lead to a higher MPC for the economy as a whole.

More reading on MPC and Keynesian Economy go here.

b) Interest rate and loan conditions

Negative - higher interest rate and loan means diminished disposable income. That is limiting to spending on household items. If saving is motivated by higher interest rates, the disposable income also falls, thus less consumption of household items.

Factor # 3. The Rate of Interest:
The rate of interest is the reward for saving. Normally people save more when the rate of interest is high than when it is low. Thus people can be induced to save more by offering a high rate of interest. If the rate of interest rises people may voluntarily curtail their consumption to save more. Thus the rate of interest and consumption spending are inversely related.

c) Expected price of the future

Positive and Negative - if the expected price of the future is going to be high (inflation), the household would like buy and stock up items which are not perishable. However, if there is an expectation that future price will be lower, then the spending will be low.

Factor # 2. Consumer’s Expectations: Price Expectations:

If people expect that an inflation is likely to occur in near future they tend to purchase durable goods whose prices may rise after some time. If people expect deflation to occur they will wait for the price to fall before making purchases. Moreover, people tend to purchase more of certain essential commodities like food articles than they normally do if their prices are likely to rise in future.

d) Creation of new product

Positive - usually a new product will be heavily promoted. This will attract more interest of purchasing this new product. Household spending on new product also dependent on the existing product. For example, new product feature of a washing machine - not every household would buy this new washing machine unless the old one is to be replaced.

Factor # 9. Sales Effort of Business Enterprises:
Finally, consumers are likely to respond favourably to sales efforts of business firms. In an age of consumerism, business firms can increase the sales of their products through advertising or various sales promotion measures. Advertising has the effect of shifting demand from one product to another. But/ as G. Ackely has opined, whether total demand for goods and services will rise as a result of advertising is debatable.

Ref:
http://www.economicsdiscussion.net/consumption-function/top-9-factors-affecting-household-consumption-and-saving/20683
Own account.