Households: spending, saving and borrowing

Last time

Before we start: last time, in Costs, revenue, objectives of firms and market structure, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

What a household does with its income

A household earns an income each month. It can spend it, save it, or, if it wants more than its income, borrow. What households choose matters for the whole economy, because household spending is the largest part of total spending.

What affects spending

Disposable income, which is income after tax. The more households have, the more they spend. Wealth and confidence: households that own property, or feel secure about their jobs, spend more. Interest rates: higher rates make borrowing dearer and saving more rewarding, so spending falls. And inflation changes what income can buy.

Rich and poor households

Rich households spend more in total. That is why a question can say rich households spend more than the average household. But they spend a smaller proportion of their income, and save a larger proportion. Poor households spend a large proportion of their income, often all of it, mostly on necessities.

The pattern of spending

The pattern of spending means what the money goes on. Low-income households spend most on food, rent and transport. As income rises, a smaller share goes on food, and a larger share goes on services, such as education, health, leisure and travel. So when GDP falls and incomes fall, households cut luxuries first and keep spending on necessities.

Saving

Saving is the part of disposable income that is not spent. Households save for emergencies, for big purchases, for children's education and for old age. They save more when interest rates are high, when incomes are high, and when they feel uncertain about the future. They save less when interest rates are low, when they are confident, or when incomes are too low to save at all.

Borrowing

Households borrow to buy things that cost more than a month's income: houses, cars, furniture and education. They borrow more when interest rates are low, when banks are willing to lend, and when they are confident about future income. They borrow less when rates rise or when they fear losing their job, because repaying becomes harder.

When interest rates rise

A rise in the interest rate affects all three choices at once. Learn this chain; it appears in monetary policy too.

Age matters

Young adults often borrow: for education, a first home, or a car, and their incomes are still low. In middle age, incomes are highest, so people save, for their children and for retirement. Retired people often spend their savings, because their income has fallen.

When GDP decreases

Here is what happens to household spending when GDP, and so income, falls. Notice that level and pattern are two different things.

Why it matters for the economy

When households spend more, firms sell more, produce more and employ more workers, so output and employment rise. But if spending rises faster than firms can produce, prices rise: inflation. When households save more, firms sell less in the short run, but banks have more funds to lend for investment.

Answering a household question

Identify questions want two short influences, such as income and interest rates. Analyse questions want the chain: what changes, how it changes spending or saving, and the result. For level and pattern, cover both: how much is spent, and what it is spent on.

Mistakes that lose marks

Mistake one: saying poor households save more because they are careful. They save little because their income is low. Mistake two: mixing up the level of spending, how much, with the pattern, what on. Mistake three: saying higher interest rates increase borrowing. The fix: link each influence to the direction of the change.

The full-marks tip

The full-marks tip: name the influence, then say which way it moves spending, saving or borrowing. When GDP changes, cover both the level and the pattern of spending.

On one card

So, on one card: household spending, saving and borrowing. Keep it for revision.