Influences on households' spending, saving and borrowing: income

Income and Household Spending, Saving & Borrowing

Households decide how to use their income each month. Income comes from three main sources:

• 💼 Wages & salaries – money earned from work.
• 💰 Capital income – profits, dividends, interest.
• 🧑‍🍼 Transfer payments – government benefits, pensions.

Think of your household budget like a pizza 🍕:

• 🧀 Spending slices are the food you eat, clothes you buy, and services you use.
• 🍕 Saving slices are the money you set aside for future needs.
• 🥤 Borrowing slices are the extra slices you take from the table, hoping to return them later.

The Marginal Propensity to Consume (MPC) tells us how much of an extra £1 of income households will spend:

MPC = ΔC / ΔY

For example, if your allowance increases from £30 to £40 and you spend £25 instead of £20, your MPC is:

MPC = (25-20)/(40-30) = 0.5

How Income Affects Spending

1. Higher income usually means higher consumption, but the increase is less than the increase in income (MPC < 1).
2. People with low income spend a larger proportion of each extra pound.
3. When income falls, households cut back on non‑essential spending first.

How Income Affects Saving

1. Households save the remainder of their income after consumption.
2. With higher income, the Marginal Propensity to Save (MPS) rises: MPS = 1 - MPC.
3. Saving can be short‑term (e.g., a savings account) or long‑term (e.g., pension).

How Income Affects Borrowing

• When income falls, households may borrow to maintain their consumption level.
• Borrowing is often limited by credit constraints – lenders assess income and credit history.
• Excessive borrowing can lead to debt distress if income does not recover.

Illustrative Table: Income Sources & Typical Household Impact

Remember, the key to mastering this topic is to link income levels with spending, saving, and borrowing decisions and to practice calculating MPC and MPS.