Spending, saving and borrowing

Meaning of the terms

Spending means paying out money to buy or hire goods and services.

Saving refers to the part of income that is not spend, the part of income that is kept for future use.

Borrowing means taking money, to return it back in the future with or without an interest.

What factors influence consumer spending?

Disposable income and spending – the propensity to spend
Disposable income is income after direct taxes and welfare benefits have been taken into account.

What matters more is the rate at which consumers increase demand as income rises. This is called the marginal propensity to consume. For example, if someone receives extra pay of MVR1000 and he spends MVR800. The marginal propensity to consume is MVR800 / MVR1000 = 0.80. The remainder is saved so the marginal propensity to save is 0.20.

Generally, people who get lower incomes tend to have a higher propensity to spend. This does not mean they spend more than the rich people, but it simply means a higher percentage of any increment to their income will be spent.

Interest Rates
Lower interest rates cuts the cost of paying the debt on a mortgage and thereby increases the effective disposable income of homeowners. One of the features of the recent recession has been the sharp reduction in official ‘policy interest rates’ by central banks. This is designed to boost consumer spending and avoid a slump. Lower interest rates will also discourage savings as interest received by savings at banks is less. What is not saved is spent.

Household Wealth
For example a sustained fall in house prices might cause a decline in personal wealth and spending as homeowners have less housing equity available to borrow. This is sometimes referred to as the negative wealth effect. Housing equity is the difference between the market value of your property and how much still has to be paid on a housing loan (a mortgage).

Consumer Confidence
For example, fears of rising unemployment and expectations of higher taxes will hit consumer sentiment and spending. If you don’t have enough confidence, you are unlikely to go ahead with major purchases such as a new car.

The supply of credit:
One of the features of the credit crunch has been a slump in the flow of credit available for many households and businesses – banks have become less willing to lend and if they do, the rate of interest on the loan has increased. The supply of mortgage finance has dried up and would-be homebuyers now need to find a bigger deposit before getting a home loan. The loan to valuation ratios have fallen that has affected people’s ability to borrow to fund property purchases.

The distribution of income: Lower income families tend to have a higher propensity to consume than better-off households (who tend to have a higher savings ratio). Thus a redistribution of income towards poorer families may have the effect of boosting total consumer demand.

Family size and commitments
An individual with a large family will end up spending more from his income

Health care
Individuals having health issues or paying heavy health insurance premium is ought to have more expenditure as compared to a person having less or no health issues or no health insurance premium liabilities.

What factors affect consumer saving?

Interest rates
Higher interest rates will encourage people to save more.
Availability of appropriate savings schemes: With more options to save money people will be attracted to save more.
Disposable income
Disposable income is the income left after paying taxes. Thus more money left in pockets will encourage people to save more.
Rate of inflation
When inflation is high people have less money left with them to save because a major part of their disposable income will be spent to satisfy their needs and wants.
Save for a future purchase
People might save with the motive to carry out a future purchase e.g. a house
Precautionary factors
People might be saving in preparation for a day when they may face financial difficulties.
Tastes and preferences of consumers
It also depends on a individuals preference. By nature, some people are more savers than others.
Consumer confidence/expectations
Consumer expectation bout future changes in the economy, e.g. risk of unemployment may lead to people saving more. If consumers expect future price rises, they are more likely to spend more now rather than later.

What factors affect consumer borrowing?

If consumers find that their disposable income is not enough to buy certain items, they may tend to borrow, if they are capable of financing the costs of borrowing.

Rate of interest
If the interest rate is low, the consumers will find it easy to borrow money. Consumers may borrow money to buy expensive durable items such as sofa sets, bedroom sets etc.

Availability of credit facilities
If credit facilities are available, consumers will tend to borrow more. Nowadays, there are various schemes, by which people can hire-purchase durable consumers goods like motor cycles.

Next topic: Expenditure patterns

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