- Consumption is defined as the total expenditure by households on goods and services in a given time period.
- It contributes to around 60% of aggregate demand, therefore being the key component.
In total, there are 5 influences on consumption:
- Disposable income – this is how much money is left after taxes and other charges are paid. The greater the amount of disposable income is, the larger the consumer spending will be on goods and services, increasing consumption and hence AD also increased.
- Savings – this is inversely proportional to spending, as any money that is not spent is saved (MPC + MPS = 1). The more money that is saved, the lower the consumption and the lower that AD is.
- Interest rates – when the Monetary Policy Committee increases interest rates; borrowing is more expensive so there’s more incentive to save. This means consumption falls along with AD.
- Consumer confidence – when individuals are highly confident in a market, they will tend to spend more money, so consumption is increased, and so AD increases too.
- Wealth effects – if the value of a person’s assets increases, the effect will be that they feel richer, and they will generally spend more in that economy. This will see a rise in consumption and AD.