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Lesson 14: Factors Which Affect Consumption (C)

Module 1: Macro Fundamental Analysis

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Video Transcript

In this video we’re going to look deeper into the component of consumption and what factors outside of changes in the price level which is what we discussed previously what factors can affect consumption either increasing it or decreasing it and therefore ceteris paribus so if all the other components stay the same increase in aggregate demand or decrease in aggregate demand so on the right hand side here in the m column we have the marginal propensity to consume to mpc so the willingness to spend this is the definition you need to know a willingness to spend each additional unit of income now when we talk about consumption or demand as the willingness to spend each additional unit of income increases demand for services and goods increases as the willingness to spend each additional unit of income decreases the demand for goods and services decreases so we’re looking at the c component of aggregate demand here and this is the consumer so we’re talking about spending when we talk about consumption so what factors outside of changes to the average level of prices in an economy can shift aggregates demand either to the left or to the right either increasing aggregate demand or decreasing aggregate demand well the first thing is a change in real disposable income so again we have that terminology real adjust for inflation disposable income is just simply income minus taxes so an increase or a decrease in taxes will increase or decrease disposable income so if a government decides to decrease income tax this will in turn increase disposable income and the marginal propensity to consume will go up because people will not only feel relatively wealthier they will be relatively wealthier because now they have higher levels of disposable income an increase and decrease in income itself so if wages go up this will increase the marginal propensity to consume because consumers will now be wealthier although we have to be a little bit careful here when we’re looking at economic growth because we know increase in wages is a shift to the left higher input costs shifts short-term aggregate supply to the left which we know is not a good place for an economy to be this is a stagflation type of scenario but it will increase the marginal propensity to consume we could have larger welfare payouts or we could even have as we discussed before helicopter money where people are having money put into their bank accounts so that’s they can go out into the economy and consume and to spend and to start to stimulate growth we could have a change in assets prices which increase the marginal propensity to consume so an increase in housing prices for example may actually make the owner of the house wealthier or it may just make the owner of the house feel relatively wealthier depending really on the size of their mortgage and the more of the home they own obviously the wealthier they are becoming if they have you know a huge mortgage and the house goes up in value it’s not really going to feed through to their own personal wealth and this is really the same with stock prices so financial assets you know an increase in financial assets holders of financial assets if they see an increase in their holdings or their portfolios will actually feel wealthier and will start to go out and will spend they will consume more the marginal propensity to consume will increase because of this so either consumers become genuinely wealthier or they actually just only have to feel wealthier to go out and consume changes in household debt so an increase or a decrease in household debt discourages or encourages spending so if households are highly indebted they will go out and spend less because they have repayments to make and also on top of that they may actually start to save some money rather than continue to spend and consume and conversely if households actually do not have much debt in any given economy they will be encouraged to go out and spend more their marginal propensities consume will increase as their debts decrease we also have consumer confidence which is very similar in a way to a change in asset prices so that just feeling of being wealthier just being bullish being optimistic so an increase or a decrease in personal prospects so job prospects so an individual outlook essentially or an increase slash decrease in economic outlook so the collective outlook you know is the economy as a whole going to be good or going to be bad those two things are obviously intimately linked because if you think that the economy is going to collapse unless you are in a certain line of work you are going to struggle to find a job and your personal prospects will be harmed as well however there are some people who will be able to separate those two and even if the economy looks to be shaky uh they may be in a position where it doesn’t really affect them too much so those two things are different but they are intimately linked and we also have down here credit now credit can be split into two different parts so the incentive to use credit and the ability to access it so just because you want to use something doesn’t mean you’re actually able to access it and just because you are able to access it doesn’t mean you actually want to use it so if there is a change in the interest rate for example and interest rates go up then there is an increase in the incentive to save which means that consumption will go down the marginal propensity to consume will go down the incentive to borrow will go down because there are higher rates there will be higher repayments so there is a disincentive the higher interest rates go to actually use credit and if interest rates go up and somebody has a variable rate mortgage this is essentially an increase or a decrease in discretionary income so similar to what we looked at up here but instead of disposable income which is just income after taxes discretionary income is income after taxes and basic living costs so mortgage would be included in that so an increase in interest rates would be a decrease in a person’s discretionary income this would decrease the marginal propensity to consume consumption would go down demand would decrease assuming all these other factors stayed the same and also credit availability so it’s no use lots of people in an economy wanting to take on credit if the banks aren’t willing to lend to them so those two things go hand in hand and increasing the willingness of banks to lend will stimulate economic growth and a decrease in the willingness of banks to lend will cause consumption to drop and it will cause demand to drop for goods and services as well so consumption overall as we know in many economies certainly in the u.s and the uk makes up about two-thirds is a very important factor of aggregate demand