Lecture Notes on Consumption and Aggregate Demand

Introduction to Consumption

• Consumption: Total spending by households on goods and services.
• Importance: Major component of aggregate demand in countries like the UK and US.
  • UK: Consumption accounts for ~66% of aggregate demand.

Aggregate Demand Equation

• Formula: AD = C + I + G + (X - M)
  • C: Consumption
  • I: Investment
  • G: Government Spending
  • X: Exports
  • M: Imports

Factors Affecting Consumption (Independent of Price Level)

• Marginal Propensity to Consume (MPC): Willingness of households to spend additional income.
• Multiplier Effect: Important to consider when AD is shifting.

Factors Influencing Consumption

1. Real Disposable Income

   • Definition: Income after taxes and national insurance, adjusted for inflation.
   • Influences:
     • Income tax cuts (marginal rate or increased tax-free allowance) increase real disposable income -> Higher MPC -> Increased consumption.

2. Interest Rates

   • Effects of Lower Rates:
     • Cheaper borrowing -> Increased spending on big-ticket items (cars, houses).
     • Lower returns on savings -> Decreased incentive to save -> Increased consumption.
   • Impact on Mortgages:
     • Variable/tracker rate mortgages: Lower monthly repayments -> More disposable income -> Increased consumption.

3. Availability of Credit

   • Low Availability: Can limit the impact of lower interest rates as banks may not lend.

4. Consumer Confidence

   • Influences:
     • Job prospects and unemployment levels.
     • High confidence: Strong job prospects, low unemployment -> Higher MPC.

5. Asset Prices and Wealth

   • Asset Prices: House prices, share prices, bond prices.
   • Wealth Effect: Rising asset prices -> Increased feeling of wealth -> Higher consumption.

6. Household Indebtedness

   • High Debt Levels: Encourage saving over spending due to risk management needs.

Additional Factors

• Age Structure of Population: Potential impact on consumption patterns.

Conclusion

• Develop a comprehensive chain of analysis linking factors to changes in consumption and aggregate demand.
• Upcoming topic: Saving determinants.

Stay Tuned: For the next video focusing on savings and their determinants.