Households

Economics · Microeconomic decision-makers. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Households can do two things with their disposable income (income after direct taxes and benefits): spend it or save it. They can also borrow, to spend more than their income.

Income is the biggest influence. As income rises, households spend more in total and also save more. The rich spend a smaller proportion of their income and save a larger proportion, because their basic needs are already met. The poor spend nearly all their income on necessities.

A higher rate of interest rewards saving and makes loans dearer, so saving rises while borrowing and spending fall. Strong confidence about jobs and future income raises spending and borrowing. Age and culture also matter.

Rules to remember

Saving = disposable income − spending
Percentage of income saved = saving ÷ disposable income × 100
Higher income: more spending and more saving in total; a smaller share is spent and a larger share is saved
Higher interest rate: more saving, less borrowing, less spending. Lower interest rate: the opposite
Low confidence (fear of unemployment): less spending and borrowing, more saving
Age: young adults borrow (education, home, car), the middle-aged save most (for retirement), the retired spend their savings
Culture: traditions and attitudes to debt, e.g. saving for weddings, or avoiding loans that charge interest

Common mistake

Saying that the rich spend less than the poor. The rich spend more in total; it is the proportion of income spent that is smaller.

Worked example

A household has a disposable income of Rs 120,000 a month and saves 15% of it. Its income then rises to Rs 150,000 a month and it saves 20%. By how much does its monthly spending change?

Saving before = 15% of 120,000 = Rs 18,000, so spending = 120,000 − 18,000 = Rs 102,000.
Saving after = 20% of 150,000 = Rs 30,000, so spending = 150,000 − 30,000 = Rs 120,000.
Change in spending = 120,000 − 102,000 = Rs 18,000.

Answer: Spending rises by Rs 18,000 a month, even though the proportion of income spent falls from 85% to 80%.

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