Case Study 6 - Disposable Income

Question 1

Economic Growth (2.1.1)

How did an increase in the UK household savings ratio impact economic growth in Q2 2024?

Answer 1

• Reduced growth: GDP growth revised down to 0.5% (from 0.6%) as higher savings (10% vs. 8.9%) lowered consumption (Page 1).
• Consumer caution: Despite 1.3% real disposable income growth, spending rose only 0.2%, slowing AD expansion (Page 1).
• Policy challenge: Government targets 2.5% long-term growth but faces a £22bn fiscal deficit (Page 2), complicating stimulus efforts.

Question 2

Characteristics of AD (2.2.1)

How did rising savings affect the components of aggregate demand (AD)?

Answer 2

• Lower Consumption (C): Savings ratio increase reduced spending (Page 1: “caution from households held back consumer spending”).
• AD shift left: Consumption fell, but growth persisted due to other AD components (e.g., potential government spending or exports).
• Case study link: AD growth slowed, contributing to 0.5% GDP expansion vs. 0.7% in Q1 (Page 1).

Question 3

Consumption (C) (2.2.2)

Why did UK household consumption rise only 0.2% despite higher real disposable income?

Answer 3

• Increased savings: Households saved 10% of disposable income (Page 1), prioritizing precautionary savings over spending.
• Economic uncertainty: Post-recession caution (“mild recession in 2023,” Page 2) and high interest rates (5%) discouraged spending.
• Paradox: Real disposable income grew 1.3% (Page 1), but savings absorbed gains, limiting consumption growth.

Question 4

Equilibrium Levels of Real National Output (2.4.3)

How did the savings increase affect equilibrium output? Illustrate with an AD/AS diagram

Answer 4

• AD contraction: Higher savings reduced Consumption (C), shifting AD left (Page 5 diagram: AD₁ -> AD₂)
• Equilibrium outcome: Lower real output (Y₁ -> Y₂) and price level (P₁ to P₂)
• Case study paradox: GDP still grew 0.5% due to offsetting factors (e.g., government spending, exports). Example: BoE signaled rate cuts to boost AD (Page 2).

Question 5

Economic Growth (2.1.1)

What role might future household savings play in UK economic growth?

Answer 5

• Potential boost: If households spend savings, Consumption (C) rises, increasing AD and growth (Page 2: “growth could yet receive a boost”).
• Risks: Persistent high savings could prolong weak AD. Government’s £22bn fiscal hole (Page 2) limits stimulus, relying on BoE rate cuts (Page 2).

Question 6

Consumption (C) (2.2.2)

How does the savings ratio relate to the marginal propensity to consume (MPC)?

Answer 6

• MPC = 1 - MPS: A savings ratio of 10% implies MPC = 0.9. However, in 2024 Q2, MPC fell as savings rose, reducing consumption growth (Page 1).
• Case study evidence: Real disposable income grew 1.3%, but consumption rose only 0.2%, indicating higher MPS (Page 1).