Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Other determinants of consumption


A number of factors other than the ones we discuss in the preceding section also influence how much households consume:


Household wealth: As well as the income households receive every year, they also have a stock of wealth: perhaps their house, their savings in the bank or their equity portfolio. The wealthier people are, the more you expect them to consume. As a result, when the stock market is performing strongly or house prices are increasing, consumption tends to rise.


Future income: People don’t just look at their current income when deciding how much to consume. Expectations about future disposable income can be just as important as disposable income today. For example, if Frieda is poor today but expects high income tomorrow, she may well consume a lot today. Similarly, if taxes are low today but you expect them to be high tomorrow, you may consume less today to pay for your impending taxes.


Interest rate: The rate at which people can borrow money has a large impact on household consumption for a few reasons:


Low interest rates mean that borrowing money to fund higher consumption today is attractive.


Low interest rates mean that saving for the future is less attractive compared to consuming now.


Low interest rates tend to increase the value of assets such as shares and houses, which increases household wealth and consumption.


Low interest rates mean lower monthly mortgage interest payments for homeowners, which increases the money they have available for consumption.


Tooling up for business: Investment

Investment (I), the third-largest component of aggregate demand, accounts for roughly 15 per cent of GDP in the UK – though, being the most volatile

component of GDP, this amount can vary substantially. Typically, during a boom (a period of above-average economic growth) investment can rise sharply, whereas during a bust (a period of below-average or negative economic growth) investment can fall sharply.


Investment is one of those words that economists use substantially differently to laypeople. To the latter, investment often refers to the purchase of shares in a company or buying a house in the hope that it will appreciate in value. To an economist, investment is the purchase of new capital goods, which are goods used to produce other goods and services in the future.

Examples of capital goods include machines, computers, buildings and so on. Firms carry out most capital goods investment; after all, they’re trying to make stuff to sell to people, and in order to make stuff, they need capital goods. (Turn to Chapter 2 for further discussion on what economists mean by the terms investment and capital.)

There is one case where economists count purchasing a house as investment: buying a newly built house (more precisely they call it residential investment). The idea is that purchasing a new house provides you with a stream of ‘housing services’ in the future. In order to count as investment, the house has to be a newly built one. A second-hand house doesn’t count because this entails the transfer of an already existing stream of housing services from one person to another.

If you think about it, deciding that buying a new house counts as investment whereas, say, buying a new car counts as consumption is a little strange. After all, a new car provides a stream of ‘car services’ in the future. The problem is, why stop there? Buying a new washing machine provides a stream of ‘washing services’ in the future, but that’s also counted as consumption and not investment. What about a new pen? Doesn’t that provide ‘writing services’ in the future?

As you can see, all sorts of little ambiguities arise, and economists had to draw the line somewhere. For whatever reason – perhaps because housing is

such an economically important service – buying a new house is recorded as investment whereas almost anything else a household would buy is considered consumption.