Explain two factors that could cause a fall in consumption

AQA AS-Level Paper 1 June 2020 Insert

Extract C (lines 3–4) states: ‘Household consumption accounts for approximately 60% of aggregate demand so has a vital role to play in the economy.’ Explain two factors that could cause a fall in consumption. (10 marks)

One factor that could cause a fall in consumption is higher income tax rates. In the UK, income taxes are progressive and they are a form of a direct tax, meaning that they can't be passed on to others. As income increases, the proportion that is taxed also increases. If income tax increases, consumers are left with less disposable income. This means that consumer spending would fall. This would have an even greater effect on consumer spending if income tax rates rise for lower income households. This is because they have a higher marginal propensity to consume, which means that if their income falls, their spending would have to fall by a lot more as they do not have much wealth or savings.

Another factor that could cause a fall in consumption is higher interest rates. Interest rates are the cost of borrowing or the reward for saving. Higher interest rates mean that it is more rewarding to save, which would lead to lower consumer spending. Additionally, higher interest rates could mean that demand for housing falls, and this could lead to a negative wealth effect for homeowners, which might reduce their consumer confidence. Those who are paying their mortgage will also have a higher monthly interest payment, which could also cause their consumer confidence and spending to fall.

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