Economics (0455) | Households

Microeconomic Decision Makers: The Household

Hello Economists! This chapter focuses on you—the individual consumer—and the choices you make every day. In Economics, a household is a single person or a group of people who live together and make financial decisions.

Why study households? Because your decisions about whether to spend, save, or borrow money determine the overall level of demand in the economy. Understanding these choices is key to understanding how markets work!

What is the Household's Main Economic Decision?

Every household receives an income (usually from wages). They must then decide how to allocate that money between three main activities:

• Spending (Consumption): Buying goods and services now (e.g., groceries, rent, entertainment).
• Saving: Putting money aside for future use (e.g., retirement, large purchases).
• Borrowing: Taking money now, promising to pay it back later, usually with interest (e.g., taking out a mortgage or a student loan).

Key Takeaway: Spending, saving, and borrowing are all linked. If you spend more, you save less. If you borrow more, you can spend more now, but you must spend less later to repay the debt.

Influences on Household Decisions (Spending, Saving, and Borrowing)

Don't worry if this seems complicated at first! We only need to focus on three major factors that push households towards spending, saving, or borrowing.

1. Income

Income is perhaps the most obvious influence. How much money a household earns dictates the scale of its decisions.

How Income Influences Decisions:

• Spending: Generally, as income increases, the total amount spent increases. However, spending on necessities (like food) tends to rise slower than spending on luxuries (like holidays or new technology).
• Saving: Households with higher incomes can usually afford to save more, as they have covered all their basic living costs. Saving increases with income.
• Borrowing: Lenders (like banks) are more willing to lend money to households with high, stable incomes because they are more likely to repay the loan.

Comparing Households Based on Income:

When looking between different households, we see a key difference in the Proportion of income spent:

• Lower-Income Households: These households spend a very high proportion, or even all, of their income just covering essentials (food, rent). They have a low capacity for saving.
• Higher-Income Households: They spend a lower proportion of their total income on essentials and have a much higher proportion available for discretionary spending (non-essentials) and saving.

2. The Rate of Interest

The Rate of Interest is crucial because it is effectively the price of money.

• For Savers, it is the reward for lending money to a bank.
• For Borrowers, it is the cost of taking out a loan.

How Interest Rate Influences Decisions:

Imagine the central bank raises interest rates (e.g., from 2% to 5%).

1. Impact on Saving:

   If the interest rate is high, the reward for saving is greater. This encourages households to delay current spending and increase saving.

2. Impact on Borrowing:

   If the interest rate is high, the monthly repayments on loans (like mortgages or credit card debt) become much more expensive. This discourages households from taking out loans, thus decreasing borrowing.

3. Impact on Spending:

   Since both saving is encouraged and borrowing is discouraged, total current spending on large items (like houses or cars, which are often bought using loans) will decrease.

Did you know? Changing interest rates is a key tool governments and central banks use to manage the economy. If they want to slow down inflation (rising prices), they usually raise interest rates to encourage saving and reduce spending.

3. Consumer Confidence

Consumer Confidence refers to how optimistic households are about their own financial future and the future health of the economy.

High Confidence vs. Low Confidence (Influence Over Time):

When households look over time, their confidence levels change, dramatically altering their decisions.

A. When Confidence is HIGH (e.g., during an economic boom):

• Households feel their jobs are secure and may expect a pay rise.
• Spending: They are happy to spend now, especially on non-essential items, because they are not worried about future income. Spending increases.
• Borrowing: They are confident they can handle debt repayment, so they are more willing to take out large loans (e.g., for a new house). Borrowing increases.
• Saving: Precautionary saving (saving 'just in case') decreases, as they feel secure. Saving may decrease.

B. When Confidence is LOW (e.g., during a recession or pandemic scare):

• Households worry about losing their jobs or face uncertainty about the future economy.
• Spending: Households cut back drastically, often postponing large purchases like furniture or cars. Spending decreases.
• Borrowing: Households avoid taking on new debt because they fear they might not be able to repay it if they lose their income. Borrowing decreases.
• Saving: Households start precautionary saving—stockpiling cash in case of emergency. Saving increases.

Analogy: Think of it like a rainy day fund. If the sun is shining (high confidence), you spend your money. If the forecast is for a thunderstorm (low confidence), you keep your cash tucked away (saving).

Comparing Household Decisions: Different Groups and Different Times

Between Different Households (Demographics)

We need to understand why decisions vary between groups of people, even with similar incomes or interest rates.

Age and Life Cycle:

This is a major difference between households:

Age Group	Typical Spending Pattern	Typical Saving/Borrowing Pattern
Young Adults/Students	Low spending due to low income, often focused on immediate needs.	High borrowing (student loans, first car loan). Low saving.
Working/Family Age (25-55)	High consumption (housing, children, transportation).	Highest income and often the highest saving (pensions, mortgages). Often high borrowing (mortgages) initially, then paying debt off.
Retired (65+)	Lower overall consumption than peak earning years.	Minimal income. They dissave—meaning they rely on accumulated savings to fund their spending. Minimal borrowing.

Other Differences Between Households:

• Culture: Some cultures place a higher value on saving for the future or family welfare, leading to higher saving rates regardless of income level.
• Expectations: A household expecting an inheritance will likely spend more now than a household facing unexpected future health costs.

Over Time (The Economic Cycle)

Household behaviour changes drastically depending on whether the economy is doing well or poorly.

When we look over time, we see cycles:

• In a boom period, overall household spending is high, precautionary saving is low, and debt levels rise rapidly.
• In a recession, spending falls sharply (as confidence collapses), saving increases, and debt levels stagnate or are actively reduced.

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Final Key Takeaways: Household Decisions

Here is a summary of the three key influences you must know:

Memory Aid: I-I-C

The three key influences on household decisions are Income, Interest Rate, and Confidence.

Factor Change	Effect on Spending	Effect on Saving	Effect on Borrowing
Increase in Income	Increases	Increases	Increases (easier to get loans)
Increase in Interest Rate	Decreases (loans are expensive)	Increases (reward is higher)	Decreases (cost is higher)
Increase in Confidence	Increases (less worry)	Decreases (less need for 'rainy day' fund)	Increases (confident in repayment)