Consumption and the savings ratio

Influences on consumption

• Disposable income (income after tax plus benefits): the main influence; higher real disposable income means more spending.
• Interest rates: higher rates make borrowing dearer and saving more rewarding, and raise mortgage payments, so C falls.
• Consumer confidence: optimism about jobs and incomes raises spending; fear raises precautionary saving.
• Welfare payments: higher benefits raise disposable income for low-income households, who spend most of it.
• Wealth effects: rising house or share prices make people feel wealthier, so they spend more (and can borrow against assets).
• Availability of credit: easier lending by banks raises spending on big items such as cars and houses.

Saving and consumption

Disposable income is either consumed or saved: Yd = C + S. So for a given income, more saving means less consumption.

The savings ratio = saving / disposable income x 100. It is the share of household disposable income that is saved.

Changes in the savings ratio

The ratio rises when confidence falls (precautionary saving), when interest rates rise, when credit is harder to get, or when people save for retirement. It falls when confidence and asset prices are high, credit is easy or real incomes are squeezed and households run down savings.

Effects: a rising savings ratio cuts C and so AD in the short run (slower growth, higher unemployment), but provides funds for investment and makes households more resilient; a falling ratio boosts AD now but may leave households indebted.

Worked example

Households have disposable income of $800 bn and save $64 bn. Find consumption and the savings ratio.

1. C = Yd - S = 800 - 64 = 736
2. Savings ratio = 64 / 800 x 100 = 8%

Answer: C = $736 bn; savings ratio 8%

Check yourself

1. Disposable income is $1,250 bn and households consume $1,150 bn. Find the savings ratio in %.
   Show answer

   8 %. S = 1,250 - 1,150 = 100; 100 / 1,250 x 100 = 8%.

2. Disposable income is $600 bn and the savings ratio is 12%. Find consumption in $ bn.
   Show answer

   $528 bn. S = 0.12 x 600 = 72, so C = 600 - 72 = $528 bn.

3. Which is most likely to reduce consumption?
   • A rise in house prices
   • A rise in interest rates
   • Easier access to credit
   • A rise in welfare payments
   Show answer

   A rise in interest rates. Borrowing becomes dearer, saving more rewarding and mortgage payments rise.

4. A large rise in share prices increases consumption mainly through
   • the multiplier
   • the accelerator
   • the wealth effect
   • fiscal drag
   Show answer

   the wealth effect. Households feel wealthier and spend more.

5. Consumer confidence falls sharply. What is the most likely effect on the savings ratio and AD?
   • The savings ratio rises and AD falls
   • The savings ratio falls and AD rises
   • The savings ratio rises and AD rises
   • The savings ratio falls and AD falls
   Show answer

   The savings ratio rises and AD falls. Precautionary saving rises, so consumption and AD fall.

6. Why might a rise in welfare payments to low-income households have a large effect on consumption?
   • Low-income households save most of any extra income
   • Welfare payments are counted as investment
   • Low-income households spend most of any extra income
   • It reduces disposable income
   Show answer

   Low-income households spend most of any extra income. They have a high marginal propensity to consume.

7. Define the savings ratio.
   Show answer

   The proportion (percentage) of household disposable income that is saved.. Savings ratio = saving / disposable income x 100.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.