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Consumption and Saving Review for AP Economics (page 2)

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By — McGraw-Hill Professional
Updated on Mar 4, 2011

Changes in Consumption and Saving

A change in disposable income causes a movement along the consumption and savings functions. Economists typically recognize four external determinants of household consumption and saving that shift the functions upward or downward.

Determinants of Consumption and Saving

  • Wealth.When the value of accumulated wealth increases, consumption functions shift upward, and the saving function shifts downward, because households can sell stock or other assets to consume more goods at their current level of disposable income.
  • Expectations.Uncertainty or a low expectation about future income usually prompts a household to decrease consumption and increase saving. An expectation of a higher future price level spurs higher consumption right now and less saving.
  • Household Debt.Households can increase consumption with borrowing, or debt. However, as households accumulate more and more debt, they need to use more and more disposable income to pay off the debt, and thus decrease consumption.
  • Taxes and Transfers.A change in taxes impacts both consumption and saving in the same direction. If the government increases taxes, households see both consumption and saving decrease because more of their gross income is sent to the government. On the other hand, an increase in government transfer payments increases both consumption and saving functions. In the case of taxes and transfers, consumption and saving functions shift in the same way.

An upward shift in consumption tells us that at all levels of disposable income, consumption is greater (CHigh). If consumption is greater at all levels of disposable income, saving must be lower (SLow), and vice versa. The only exception is the case of taxes and transfers described above. Figures 13.3 and 13.4 illustrate these simultaneous shifts in the opposite directions.

Consumption and Saving

Consumption and Saving

  • With the exception of taxes and transfers, when the consumption function shifts upward, the saving function shifts downward.
  • With the exception of taxes and transfers, when the consumption function shifts downward, the saving function shifts upward.
  • When taxes increase (or transfers decrease), both consumption and saving functions shift downward.
  • When taxes decrease (or transfers increase), both consumption and saving functions shift upward.

Review questions for this study guide can be found at:

Consumption, Saving, Investment, and the Multiplier Review Questions for AP Economics

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