Micro‑economic decision‑makers: Households
Objective
To understand how consumer confidence – together with the other key influences listed in the Cambridge IGCSE/A‑Level syllabus – affects households’ decisions on spending, saving and borrowing, and to evaluate the wider economic implications.
1. What is “consumer confidence”?
Key definition (AO1)
Consumer confidence is “optimism or pessimism about present and future income, employment and overall economic conditions.”
It is measured by surveys such as the GfK Consumer Confidence Index, the OECD Consumer Sentiment Indicator or national consumer‑confidence questionnaires. The index is expressed as a score (higher = greater optimism).
2. Influences on household behaviour (AO1)
The syllabus identifies five main influences. Each one shifts the consumption, saving or borrowing decisions in a predictable way. The “Why this matters” column links the influence to the relevant part of the syllabus.
| Influence | Effect on spending, saving & borrowing | Why this matters (syllabus link) |
|---|
| Disposable income (Yd) | - Higher Yd → ↑ autonomous consumption (a) and ↑ total consumption (C = a + bYd).
- S = Yd – C. When Yd rises, saving usually rises (the proportion saved depends on the MPC).
- More income raises the ability to repay, so households are willing to borrow more for larger purchases.
| Disposable income shifts the consumption function C‑Y and the saving function S‑Y (AO2). |
| Interest‑rate level (r) | - Higher r makes saving more attractive and reduces current consumption; lower r does the opposite.
- Higher r → ↑ incentive to save (upward shift of the saving function). Lower r → ↓ saving.
- Borrowing cost is directly linked to r; low rates increase the demand for credit, high rates discourage it.
| Interest rates affect the cost of credit and the return on saving – a core part of the “interest‑rate” influence (AO2). |
| Consumer confidence | - High confidence raises autonomous consumption (a) and can increase the marginal propensity to consume (b).
- High confidence reduces precautionary saving, shifting the saving curve down; low confidence raises precautionary saving, shifting it up.
- When households expect higher future income, they are more willing to borrow; pessimism reduces borrowing.
| Confidence directly influences the autonomous components of the consumption and saving functions and the demand for credit (AO2). |
| Age / life‑cycle stage | - Young adults (students, early‑career) tend to spend a larger share of income; older households (near retirement) spend less and save more.
- Savings peak in middle age (high earnings) and again in retirement (precautionary).
- Younger households borrow more for education or first homes; older households borrow less, focusing on debt repayment.
| Life‑cycle considerations explain variations in C, S and borrowing across age groups (AO2). |
| Cultural & social factors | - Culture shapes attitudes to consumption (e.g., status‑driven spending vs. frugality).
- Some societies emphasise saving for future generations, raising the saving rate.
- Norms affect willingness to take credit (e.g., aversion to debt in certain communities).
| Social and cultural influences are listed explicitly in the syllabus as determinants of household behaviour (AO1). |
3. The role of confidence in the three key decisions (AO2)
3.1 Spending (Consumption)
The simple consumption function is:
C = a + bYd
- a – autonomous consumption: the amount households would spend even if disposable income were zero (e.g., basic necessities, credit‑financed purchases).
- b – marginal propensity to consume (MPC): the extra amount spent for each additional unit of disposable income.
Confidence‑driven shift: High confidence raises expectations of stable or rising future income, so both a and, often, b increase. Graphically the C‑Y curve shifts upwards/rightwards. Low confidence produces the opposite shift.
3.2 Saving
Savings are the residual of disposable income after consumption:
S = Yd – C = (1‑b)Yd – a
- When confidence is high, the precautionary motive weakens → a (autonomous saving) falls and the term (1‑b) may fall because a larger share of income is spent.
- Low confidence strengthens precautionary saving → a rises and the saving function shifts upwards (more saving at each income level).
Thus confidence moves the saving curve up or down, mirroring its effect on the consumption function.
3.3 Borrowing
Households borrow to smooth consumption over time. The inter‑temporal budget condition can be written as:
\(\displaystyle \frac{Ct}{(1+r)^t} + \frac{C{t+1}}{(1+r)^{t+1}} = It + \frac{I{t+1}}{(1+r)^{t+1}}\)
- Higher confidence raises the expected future income term \(I_{t+1}\), making the desired consumption bundle larger relative to current resources – borrowing becomes attractive.
- Low confidence reduces expected future income, so households prefer to save or repay debt rather than borrow.
4. Interaction with macro‑economic policy (AO2)
- Monetary policy: A cut in the policy rate lowers the cost of borrowing and can boost confidence by signalling supportive conditions, leading to higher consumption and credit demand.
- Fiscal policy: Tax cuts raise disposable income and usually raise confidence; tax increases have the opposite effect.
- Inflation expectations: If households expect high inflation, they may accelerate spending now (to avoid higher future prices) even if confidence is moderate.
- Wealth effects: Rising house prices or stock‑market gains increase perceived wealth, lift confidence and shift the consumption function upwards.
5. Evaluation – why confidence matters for the whole economy (AO3)
| Positive effects of high confidence | Potential downsides of high confidence |
|---|
- Higher consumer spending → stronger aggregate demand → higher output and employment.
- Increased borrowing can finance investment (home‑improvement, education) that raises future productivity.
- Greater tax receipts from higher consumption give governments more fiscal space.
| - Excessive borrowing may create high household debt, making the economy vulnerable to interest‑rate rises or a downturn.
- Over‑optimism can fuel asset‑price bubbles (housing, equities).
- If confidence is driven by temporary factors, a sudden fall can cause a sharp drop in consumption – a “consumer‑confidence shock”.
|
| Positive effects of low confidence | Potential downsides of low confidence |
|---|
- Higher precautionary saving provides a buffer against future income shocks.
- Lower borrowing reduces the risk of debt‑service problems for households.
| - Reduced consumption depresses aggregate demand, potentially lowering output and raising unemployment.
- Lower borrowing may delay investment in education, housing or small‑business expansion.
- Governments may see falling tax revenues, limiting fiscal stimulus options.
|
6. Summary table – effect of confidence on the three decisions (AO2)
| Decision | High confidence | Low confidence |
|---|
| Spending (C) | ↑ autonomous consumption (a); possible ↑ MPC (b); C‑Y curve shifts right/up. | ↓ a; possible ↓ b; C‑Y curve shifts left/down. |
| Savings (S) | ↓ precautionary saving; saving curve shifts down. | ↑ precautionary saving; saving curve shifts up. |
| Borrowing | ↑ expected future income → ↑ demand for credit; borrowing cost (r) becomes more relevant. | ↓ expected future income → ↓ demand for credit; focus shifts to debt repayment. |
7. Suggested diagrams for exam answers (AO2)
- Consumption function (C‑Y) shift: Show the upward/rightward shift when confidence rises and the opposite shift when it falls.
- Savings function (S‑Y) shift: Illustrate an upward shift (more saving) under low confidence and a downward shift under high confidence.
- Credit‑market diagram: Plot the demand for credit (downward‑sloping) against the interest rate; shift the demand curve rightward when confidence is high.
- Aggregate‑demand (AD) impact: Use a simple AD‑AS diagram to link a confidence‑driven shift in C to a rightward shift in AD, noting the possible effects on output and the price level.
8. Exam tip (AO3)
When a question asks you to “analyse the effect of consumer confidence on household behaviour”, follow this structure to maximise marks:
- Definition: State the key definition in one sentence.
- Mechanism: Explain how confidence influences each of the three decisions (spending, saving, borrowing) – refer to the relevant equations (C = a + bYd, S = Yd – C) and curves.
- Diagram: Draw at least one labelled diagram (normally the consumption function) showing the shift caused by confidence.
- Interaction/Evaluation: Briefly discuss how another factor (e.g., interest rates, fiscal policy, wealth effects) might reinforce or offset the confidence effect.
- Conclusion: Summarise the wider macro‑economic implications (impact on AD, output, employment, debt levels).