Chapter 3.2
Households
Households decide how much to spend, save, or borrow based on three forces: their income, interest rates, and how confident they feel about the economy.
Summary
💰 Spending (Consumption): Households spend more when they have higher disposable income, interest rates are low, and confidence is high. They spend less when these factors reverse.
🏦 Saving: Saving behaviour differs by income level. High-income households save a lot of extra income; low-income households spend most of it. Interest rates and confidence also shape saving decisions.
📊 Borrowing: The ability and willingness to borrow depends heavily on income, interest rates, and confidence—but low-income households face much higher barriers and costs.
🎯 The Key Insight: The same change (e.g., rising interest rates) affects low, medium, and high-income households very differently. Exam questions always test this comparison.
The Influences on Household Spending
What is Consumption?
Consumption and spending mean the same thing in economics: the money households spend on goods and services. Every time a household buys groceries, pays for electricity, or goes to the cinema, that's consumption.
The amount households consume is heavily influenced by three main forces: how much income they have left after taxes (disposable income), the cost of borrowing (interest rates), and their confidence in the economy's future.
Factor 1: Changes to Income
Disposable income is the money left in a household's pocket after they pay taxes and receive any government benefits. For example, if someone earns £2,000 per month, pays £300 in taxes, and receives £50 in benefits, their disposable income is £1,750.
The Golden Rule
When disposable income increases → households spend more.
When disposable income decreases → households spend less.
It's intuitive: if you have more money in your pocket, you buy more. If you have less, you buy less. This relationship is so reliable that economists call it the consumption function.
Worked Example
Scenario: The government cuts taxes for all workers.
✓ Disposable incomes increase across the economy.
✓ Households now have more money to spend.
✓ Shops, restaurants, and supermarkets see higher sales.
✓ Businesses hire more workers to keep up with demand.
Factor 2: Changes to Interest Rates
Interest rates are set by the government's central bank (in the UK, the Bank of England). They control the base rate, which is like the foundation rate for all borrowing and saving in the economy.
When the central bank raises the base rate, commercial banks raise the interest rates they charge on loans and mortgages. When the base rate falls, borrowing becomes cheaper. This directly affects household spending in two ways:
| Higher Interest Rates (↑) |
Lower Interest Rates (↓) |
|---|