Key Factors Influencing Consumption and Aggregate Demand Explained

Hi everybody. Consumption is the total spending by households on goods and services in the economy. For countries

like the UK and the US, consumption is a massively important part of aggregate demand. In the UK, for example, it

accounts around 66% of aggregate demand. In the US, it's something similar to that. Remember what the equation is for

aggregate demand. Aggregate demand is C plus I plus G plus X - M. We in this video are going to look at reasons why

consumption can increase or decrease for reasons independent of the price level. So nothing to do with the price level,

other reasons. So these are all factors that can then therefore shift aggregate demand right or left as a result of

influencing C in the aggregate demand equation. Before we get started, something to bear in mind is to use the

phrase the marginal propensity to consume in your chains of analysis here. So when you're writing long paragraphs

as to how these factors can influence CE using the marginal propensity to consume will make you look amazing and more

professional in your writing. The marginal propensity to consume is just the willingness of a household to spend

any extra income that they earn. All right? So it's something that you can use throughout. I'll be using it. Use it

as I do basically. But also make sure you mention the multiplier effect. Anytime the ad is shifting for any of

these factors, let's say, you can always bring in the multiplier effect to bolster your analysis. Uh watch my video

on the multiplier effect to understand it and then to know how to use it in your analysis. So what factors can

affect consumption uh independent of the price level? Well, the level of real disposable income where real means

adjusted for inflation and disposable income is income left after taxes and national insurance have been paid. So um

one reason why disposable income can increase is maybe if income taxes have been cut in the economy. So cuts in the

marginal rate of income tax or increases in the taxfree allowance which is the level of income um you're allowed to

earn before taxes are paid before income tax is paid. So if you increase the tax re allowance or if you cut the marginal

rate of income tax um that is going to increase the level of real disposable income which will therefore increase the

marginal propensity to consume and therefore increase the level of consumption in the economy. If interest

rates are cut for example then the cost of borrowing falls and the rate of return on saving falls. If the cost of

borrowing falls, then that increases the incentive for consumers to go and borrow money because it's cheaper to do so now

and to spend that money on expensive items like cars, like houses, like furniture, like jewelry for example. And

that will increase consumption in the economy. If interest rates are cut, the rate of return on saving decreases. So

that reduces the incentive to save and instead any income that's generated might go into consumption uh as a

result. And that increases C. uh a lot of uh UK households will have mortgages right the way in which they can finance

buying a house and monthly uh mortgages have to be repaid back. So there are monthly repayments on mortgages and um a

lot of mortgages in this country are variable rate mortgages or tracker rate mortgages where the level of repayments

or the interest repayments are tracked to the base rate in the economy to the central bank interest rate. So if

interest rates are cut, it means monthly repayments could fall for households who have variable rate mortgages or track

rate mortgages, which means monthly they have more disposable income to be able to spend in the economy, increasing C in

that way. You also must bear in mind the availability of credit. If the availability of credit is low, then this

can reduce the impact of borrowing. this can reduce the impact of uh lower interest rates um because simply banks

are not willing to lend if the availability of credit is very very low um so that's something that can stop

this happening it's something else which will affect C uh in the aggregate demand equation consumer confidence if there is

high consumer confidence consumers going to have a higher marginal propensity to consume what can affect consumer

confidence well it's job prospects and the level of unemployment in the economy so don't be vague in your writing and

say, "Oh, you know, expectations about the state of the economy." That is true, but then be more specific what you mean

by that. Link very much to job prospects and the level of unemployment. So, if people expect that they're going to get

promoted soon or that their job prospects are very, very strong, they're going to be more likely to spend money,

their MPC is going to be higher. If the level of unemployment is very low, then individuals will feel very bullish in

their job. they'll feel very confident in their job prospects and are therefore more likely to spend money and not uh

find a reason to save necessarily that period of time. Asset prices, now this is very important. Asset price is linked

to wealth. How wealthy people feel. The wealthier people feel, the more likely they are to spend money. The higher the

marginal the higher the marginal propensity to consume. So what do we mean by asset prices? Well, things like

house prices, share price is a very good example. bond prices. If these are going up and individuals hold such assets,

they feel wealthier. They're more likely to spend money. In countries like the UK, there's a very strong correlation

between asset prices like house prices and share prices and the level of consumer spending in the economy. So

that links to to wealth and wealth links to consumer spending. How wealthy people feel in this case. their income hasn't

actually changed but they just feel like they are more rich hence why they are more willing to spend their money and

also the level of household indebtedness. If there is a huge amount of household indebtedness in the economy

families living in huge debts then individuals are more likely to save that money as opposed to spending that money

just in case things go bad and they need to repay those debts quickly. they'd rather save that money to have uh a pool

of money in the bank to then pay off debts in case things go bad, i.e. they lose their job or something like that

takes place or interest rates rise. So the greater amount of household indebtedness, the greater amount of

saving and therefore less consumption taking place in the economy. So these are all the main factors that can affect

consumption. There are other factors too like the age structure of the population like weather you can also argue um as

well which can affect consumption but these are the main ones. The key thing for you is to be able to develop a chain

of analysis linking to consumption increasing or decreasing and therefore aggregate demand increasing or

decreasing using such phrases. Thank you so much for watching guys. Stay tuned for the next video where we're going to

look at savings, the determinant of saving.