Consumption

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    Consumption is total consumer expenditure on durables, non-durables and services. Consumption is the largest component of AD, consumption makes up roughly 67% of AD.

    An increase (decrease) in consumption will increase (decrease) AD and shift AD right (left). Many factors could increase consumption:

    1) Real Disposable Income.

    A rise in real disposable income means consumers have more income to spend so they buy more goods.

    2) Direct Taxes.

    A fall in direct taxes increases consumers’ real disposable income so consumption rises.

    3) Confidence/Expectations.

    As consumers become more confident about the economy (and their own future income) they buy more goods so consumption rises.

    4) Interest Rate.

    A fall in interest rates means the cost of borrowing falls so consumers take out more loans and buy more goods (especially credit-bought items like T.V.s and home appliances). Moreover, the return on savings falls so saving becomes less attractive and consumption becomes more attractive. Furthermore, a fall in interest rates lowers mortgage repayments, consumers’ debt falls, real disposable income rises and consumption rises.

    5) Assets.

    As house prices rise, homeowners’ wealth rises inducing a wealth effect. Because consumers feel wealthier they will buy more goods and services so consumption rises. Also, a homeowner can borrow more against the higher value of their home and increase consumption (equity withdrawal).

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