Some Factors that Determine Consumer Spending
Many factors have an influence on the total level of consumer spending in an economy.
- Real incomes – if people’s money wages rise faster than prices, then real incomes will increase and this leads to a higher level of real purchasing power
- Direct and indirect taxation – if there is a cut in direct taxation then, other factors remaining the same, consumers will experience an increase in their disposable income and spending power. In contrast, a hike in indirect taxes such as import duties or VAT will cause prices to rise and real incomes to decline.
- Interest Rates – lower interest rates cuts the cost of paying the debt on a mortgage and increases the effective disposable income of homeowners. In recent years many central banks around the world have made deep cut in interest rates in a bid to stimulate consumer demand. Official interest rates in the UK have been at 0.5% since March 2009.
- 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 property and the outstanding mortgage loan.
- 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 or kitchen.
- 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 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.
- Demographics: The size and growth rate of a country’s population and the age structure has a direct effect on total consumer spending. Some countries have a strongly positive natural rate of population growth perhaps aided by net migration of labour. An expanding population will add to demand for many different goods and services including housing, health care and education.
