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Wealth Effects on Household Final Consumption

Household Consumption and Savings

Household consumption and savings are important issues with regards to finding out the condition of the economy, the wages and employment level, the expected increase in the GDP, the current market movement, and the speed of working of the economy (Coskun et al, 2018). The consumption function is the relationship between disposable income and current consumption. This concept is used to understand the current consumption and saving function of the household of a territory. The importance of consumption theory can be understood by the fact that there is no topic in a macroeconomic analysis that has such a long, deep, and detailed literature but the choices of households on how to make the consumption and saving pattern, it is believed that every human is a little different from other, and thus finding a general tendency in these theories is as much difficult. This theory of consumption is a key idea of Keynes' general theory. Thus numerous theoretical and empirical theories have been given, some of which are abstract, general, or mathematically presented.

 Consumption equals autonomous consumption with the propensity to consume and is multiplied by disposable income. It is assumed that consumptions are always positive and those households consume something even if the income is zero whether by a number of other sources be it government subsidies or welfare schemes which ultimately satisfy the function of consumption by households (Coskun et al, 2018). If the households expect a larger income in the future or have accumulated wealth in the past, autonomous consumption will be larger from both the reasons, thus this is related to current past and future incomes. It is also assumed that propensity to consume is always positive and that the marginal propensity to consume decreases as an increase in wealth. The propensity to consume is the proportion of income and consumption expenditure of a person. For example, if a person is having an income of $ 1000, he is consuming $ 700 and saving $ 300 which is 30%, but if the income increases to 1500, the person is expected to consume 975 $ which is 65 %, and save remaining which is 35 %.

The importance of the household consumption and savings lies in the fact that it reflects the current consumption pattern which will decide the production and supply equilibrium of the future and that the investments will be pathed according to the analysis, thus it is needed to find out the consumption currents and patterns to exactly predict the future policies, monetary policy, and other welfare schemes can be accurately made (Cassidy & Bishop, 2018). In addition to this, the estimates of GDP are also made out based on income and consumption, there is a separate method of GDP calculation based on consumption pattern which is necessary sometimes due to factor variations, and for example, the Indian GDP is calculated based on consumption. The key behavioral study matter is the household's division of consumption and savings of the total earnings. Many factors affect that decision which is first, the basic elements of consumption which are required even if the income goes down and are generally dependant on the factors of status and society of the consumer, the relationship between the per capita GDP and willingness of the households to consume (propensity) which decrease with increase in income, thirdly the median age of the population also has its effects on the propensity to consume, fourthly, the interests rates of the economy also hold responsible, and lastly life expectancy of the consumer, longer life expectancy will result in increased savings and lesser consumption.

To conceptualize the household consumption pattern independent of the other expenditure factors like government consumption, trade and investment are difficult because these are interrelated and affect each other. These factors affect consumer behavior concerning consumption, investment, and savings.

Evolution, Volatility, and Noting Trends of Consumption and Savings

The per capita income and expenditure in terms of consumption have increased by an average of two percent in Australia since 1980 which shows good growth in the GDP and income distribution (Finley & Price, 2014). A constant increase in household consumption is a sign of income equality, on the contrary, if the income and consumption are not increasing or decreasing linearly, then economists argue that for income inequality and a more curved Gini graph (CEIC, 2020). However, there is always the possibility of important trends that can be masked by the aggregate numbers about income and spending but a linear increase in income and consumption mars a possibility of the economy’s path towards income equality. Thus an examination is a must on how the income and expenditure are distributed to get the real picture of the state of the economy. The other factor is the sensitivity of the household towards shock can be altered by which households are savings and which is consumption at a particular period. Exemplifying it, a huge increase in income will cause a huge surge in the spending aggregate even if the shock is concentrated only on a segment of households whose spending is more sensitive to their income.

For the first time 2009-10, the Australian government released data on household consumption and savings which included the household-level information from the agencies Household expenditure survey (HES) and Survey of Income and Housing (SIH) combining the aggregate data with national accounts (Finley & Price, 2014). Further discussion is how the pattern of distribution and consumption changed over time in Australia

The distribution of spending and savings in Australia in the data are with many of the facts about consumption. For instance, data show that on average the income, saving, and consumption make a hump pattern over years, this data is referenced by persons of 45 to 54 years of age which are considered the primetime of working life (Freestone et al, 2012). Consumption is more evenly distributed in this age section than income which proves the theory that marginal propensity to spend goes on decreasing with an increase in income and the abilities of the households to maintain consumption in their lifetime with the help of savings and loans. It proves the theory of the life cycle hypothesis which says that an individual average his lifetime consumption maintaining the future needs and current consumption.

 The breakdown of spending and consumption pattern in Australia among different income groups, the consumption for necessities decreased with an increase in income, while the share of non-necessary items increased with income increase, as expected (Freestone et al, 2012). Low-income households maintain their priority of necessary expenditure while a higher share of discretionary services is done by high-income groups. Non-durable goods and rents are the sections that eat up a bigger amount of low-income groups.

Finally, the long term trend, the most prominent in the decades was the reallocation of spending away from goods towards services. Between 1986 and 2013, consumption of households on goods decreased from half to one-third of total consumption, while share on services increased from half to two-thirds (Mat5hews, 2016).

Theories of Consumption and Savings

The lifecycle hypothesis of consumption theory says that young households have a tendency of increasing consumption by loaning against their expected future income. The middle-aged households have a tendency of saving in their peak earning ages and old aged households tend to consume their savings accumulated from their earlier investments into such services (Parker, 2010). Secondly, there is a permanent income hypothesis which explains the smoothness of income-expenditure in a relative fashion evenly over the lifetime of a household. It says that that household spends in a linear way with respect to his permanent level of income and borrow or save money in order to avoid the fluctuations during the lifetime, thus this theory concludes that consumption varies less than income (Parker, 2010).

Here it is to be noted that there is a general phenomenon that is followed in these theories that total consumption of the households can be separated in parts in order to find out the different categories of goods and services which the households have taken depending upon the income, age and different categories which can affect these habits. Older households have a tendency of lesser consumption of durable goods then do young households, because they have obtained such goods already during their lifetime; however older households spend more on the essential services like a health than younger ones. Younger households spend more on discretionary services like travel, hotels, and entertainment services and lesser on essential ones. There is another theory of the relative income hypothesis which is not relevant today and is discarded by the economists.

Published Studies

The national savings as a share of GDP fell during the period of 1970 to 1980 (Cokis & MaClouglin, 2020), which shows a decline in household and government savings. But the investment over this period fell very little and thus the current account deficit of Australia widened during this period to 4 % (Cokis & MaClouglin, 2020). Till the 1990s, the national savings remained stable, after that it started to increase till the 2008 financial crisis (Lex, 2012) which means savings of households shadowed the government's decline in savings. Investments started to decline proportionate to GDP in 2008 when the financial crisis met the world. Then the savings rate again increased with led to a decline in the CAD from 4 to 2.25 % (Cokis & MaClouglin, 2020).

Australia’s investment as a proportion of GDP is higher than other advanced economies and recently it has gained upside momentum further in this trend which shows a strong tendency of development and equality. After the period of the 2008 debt crisis, other advanced economies recovered well in gross national savings as compared to Australia which remained stable over the level on which the decline was stabilized due to the crisis. Australia’s national savings was 27 % in 2011 as compared to 19 % for big developed countries (Cokis & MaClouglin, 2020), thanks to the new mining projects of Australia.

Consumer Behavior in The Pre and Post-2008 Financial Debt Crisis

Until the 2008 financial crisis, Australian was more inclined towards consumption, the household savings ratio is from the 1980s to 2000 fall from 15 % to -2 % (Cokis & MaClouglin, 2020) which shows greater consumption. This was due to the financial deregulations, opening up of the economy, and an increase in wealth. Then the global financial debt crisis shifted consumer behavior to a higher degree and the gross savings ratio started to rise again, because of the past loans and debts and strong growth in wealth. From 2007 to 2008 the Australian savings ratio rose from 4 % to 11.2 %. The stimulus package which was supposed to increase the consumption was also saved by the Australians to a larger degree.

The Adjustments of Consumer Behavior during the 1970s to 2010s

The decline in the savings ratio started to reverse in the 2000s and currently, it is around the level when it was 1980s, thus the habit of Australians to spend more was corrected by the 2008 financial debt crisis (Cokis & MaClouglin, 2020) and now the savings rate are proportion ting at a balanced rate of the GDP, which is a very good sign as economy thrives not on a single factor of consumption, or savings but a balanced approach between these tendencies works well for an economy. The curves of Australian savings and consumption and a shock between it in 2008 proves the theories of life cycle hypothesis and long term trend (Cokis & MaClouglin, 2020) in which consumer makes a stable consumption and savings over a lifetime through loans and debts and adjusts them with the sudden shocks of a lifetime.

Conclusion and Recommendation on Household Consumption and Savings in Australia

It has been noted that household consumption and savings behavior is very necessary to be observed and predicted as a balance in an economy is maintained not only by savings, consumption, or investments but by the balanced growth and proportion of all three. Thus to save an economy the governments respond by giving up stimulus packages or by austerity measures. It is recommended that austerity measures are less likely to work in a financial crisis because people are already prone to save in such a time, thus Australian government’s decision to give a stimulus package has automatically balanced the consumption and savings ratio by Australians as they saved from the package a lot. The great depression of 1925 and the 2008 financial crisis indicated with facts that governments who were inclined to stimulus packages thrived and those who gave importance to austerity measures were not able to maintain the economy compared to former ones.

References for Household Consumption and Savings in Australia

Cassidy, N. & Bishop, J. (2012) Trends in national saving and investment. Retrieved from https://www.rba.gov.au/publications/bulletin/2012/mar/2.html

CEICdata (2020) Australia gross savings rate. Retrieved from https://www.ceicdata.com/en/indicator/australia/gross-savings-rate

Coskun , Y., Atasoyer, B., Morri, G. & Alp, E. (2018) Wealth effects on household final consumption: stock and housing market channels. Int. J. Financial Stud. 6(2), 57.

Finley, R. & Price, F. (2014) Household saving in australia. Retrieved from https://www.rba.gov.au/publications/rdp/2014/pdf/rdp2014-03.pdf

Freestone, O., Gaudry, D., Obeyeskere, A. & Sedgwick, M (2012) The rise in household saving and its implications for the Australian economy. Retrived from http://www.eiu.com/industry/article/441292228/australia-post-crisis-shift-in-consumer-behaviour/2013-12-03

Lex (2012) Microeconomics review: imports & exports. Retrived from https://hubpages.com/education/Micro-Imports-Exports

Mathews, T. (2016) The effect of chinese macroeconomic news on australian financial markets . retrieved from https://www.rba.gov.au/publications/bulletin/2016/dec/pdf/rba-bulletin-2016-12-the-effect-of-chinese-macroeconomic-news-on-australian-financial-markets.pdf

Parker, J. (2010) Theories of Consumption and Saving. Economics 314 Coursebook. Retrieved from https://www.reed.edu/economics/parker/s11/314/book/Ch16.pdf

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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