Households » Spending, Saving and Borrowing

What households do with their money

A household is a person or group of people living together, such as a family. Every household has to make choices about money. It can do three things:

• Spending: using money to buy goods and services now, such as food, rent and clothes.
• Saving: keeping money for the future instead of spending it, for example in a bank account.
• Borrowing: getting money from someone else, such as a bank, which must be paid back later, usually with interest.

Five main influences decide how much a household spends, saves or borrows: income, the rate of interest, confidence, age and culture.

Income

Income is the money a household receives, for example from wages, profits or gifts. Higher income usually means more spending and more saving, because there is more money to share out. Lower income usually means less of both, and households may have to borrow to cover their needs.

What really matters is disposable income: the income a household has left to spend or save after income tax and other deductions have been taken away.

Take Dara, a made-up worker in the country of Kelvar. She earns $2,000 a month and pays $300 in income tax. Her disposable income is $1,700. If the government raises income tax, her disposable income falls, so she is likely to spend and save less.

Households with different incomes also behave differently. A household on a very low income must spend nearly all of it on basic needs such as food and housing, so it can save very little. A household on a high income can afford to save a larger amount.

Key terms:

• Income: money received by a household, for example wages.
• Disposable income: income left after income tax and other deductions.
• Saving: income that is not spent, kept for the future.
• Borrowing: receiving money that has to be paid back, usually with interest.

The rate of interest

The rate of interest is the percentage a saver is paid for keeping money in a bank, and the percentage a borrower pays for a loan. You met the bank's side of this in the lesson on central banks and commercial banks. Here we look at how it changes what households do.

For example, in the made-up country of Tobria, interest rates fall from 8% to 4%. A family that wanted a new fridge but was put off by the cost of a loan now takes one out and buys it.

Confidence

Consumer confidence is how positive households feel about their own jobs, their income and the future of the economy.

• High confidence: households expect to stay in work and see their income rise. They are happy to spend and to borrow, and they feel less need to save.
• Low confidence: households fear losing their jobs or expect hard times. They cut spending, borrow less and save more as a safety net.

Example: a large factory in the made-up town of Marden announces it will close. Local households become worried about their jobs. Many put off buying a new car and start saving instead, even though their income has not yet changed.

Age (the life-cycle pattern)

People's needs and income change as they get older. The life-cycle pattern describes how spending, saving and borrowing change over a person's life.

Stage of life	Typical pattern
Young adult	Low income, so little saving. Often borrows, for example for study or a first home.
Middle age	Highest income. Repays loans and saves most, but also spends on a family.
Retirement	Lower income. Spends from past savings, so new saving is low.

Remember this is a typical pattern, not a rule. Some young people save hard and some older people still borrow.

Culture

Culture means the beliefs, values and customs shared by a group of people. These affect what people think is worth buying and whether borrowing is acceptable.

• In some societies, saving for the future and for the family is seen as a duty, so households save a large share of their income.
• In others, spending on festivals, weddings or gifts is expected, so a bigger share of income is spent.
• Some religious beliefs discourage paying or receiving interest, so households that follow them may avoid ordinary loans and savings accounts.
• In some communities borrowing is seen as normal, and in others it is seen as something to avoid.

This is why two households with the same income in different countries may make quite different choices.

Exam-style question

Read this made-up context. In the country of Valdoria, income tax has just been cut and interest rates have risen. A survey shows that households feel confident about their jobs. Many young adults in Valdoria borrow to pay for study, while many retired people live off their savings.

(a) Define disposable income. [2 marks]

(b) Explain how a rise in the rate of interest may affect households' saving and borrowing. [4 marks]

(c) Explain two reasons why retired people and young adults in Valdoria may spend, save and borrow differently. [4 marks]