Influence of Income Variation to Individual Consumption Choices

Document Type:Essay

Subject Area:Economics

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These habitual variationsrange from pre-cautionary topost-action measures implemented after the actual change in the income. Consumption accounts for more than two-thirds of the national gross domestic product, which makes it important for macroeconomics. Precisely, expenditure,savings, insurance, growth, borrowing,change of supply, and income smoothing activities constitute considerable factors of consumption highly influenced by a variation in income. These factors suggest that income directly proportionate to expenditure for alow and highwhile saving for moderate-income earners. Expenditure directly relates to and relies on income levels since consumption relies on the available funds for distribution. Aguiar and Hurst(2007) describe a drop in expenditure upon the retirement in all level of income earners. An anticipated long-term increase or decrease in the income influences the levels of saving.

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According to Souleles (2002), a significant number of respondents consider saving as a prime consideration upon increase of their income. However, Shapiro and Slemrod(2009) detail thatfor low-income households, an increase in income results in a direct accretion in expenditure with little savings if any. The minimal liquidity perhaps explains theLow-income household's expenditure. Variation in income influences household liquidity and by extension the ability to face unprecedented, irregular, and urgent needs. as a mitigation, factor households embrace insurance covers for various insurable goods and situations. A long-term and predictable decrease in income lowers the family liquidity, the ability to save, and thus enhance the need to invest in the insurance(Blundell, Pistaferri, & Preston 2008). According to Ashenfelter, Layard, and Card (2010), insurance comprises one of the main precautionary approaches to variation in income.

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Ashenfelter, Layard, and Card (2010) found out that 37% of long-term predicaments are insured against. One such source includes borrowing from friends, family, and other projects or seeking interest-based loans from institutions. Generally, borrowing lowers the household’s consumption with intent to meet both the needs as well as repay the funds within the required timeline. For short-term income shock, low-earning families experienceimmediate considerable strain with a negative variation on their income as described by Ashenfelter, Layard, and Card (2010). Ashenfelter, Layard, and Card (2010) demonstrate borrowing as spreading an occurrence over time to lower the immediate effect. Over the period of repaying, the household contains a given activity to raise extra funds, whichlimit the family’s laxity to fully consume the income as expected.

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The need for further intensive savings decreases enhancing current expenditure. They, therefore, contribute to current and future consumption patterns. It further contributes to changes inconsumption,areas of investment, and sources of commodities. Income level contributes to the selection of commodities, activities, and outlet channel. High-income earners tend to seek durable goods whereas low-level income earners shun from them (West, Banerjee, Phipps, & Friedline, 2017). Life-Cycle Hypothesispredicts that earners save finances for future consumption. The two propose that economists can predict consumer behavior after a variation in income. However, the findings suggest that different factors outside the hypotheses contribute to decisions made by households on the expenditure. Some of the empirical findings differ with the expectations of the hypotheses, which imply that the two fail to consider all the factors.

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For instance, upon retirement, people tend to reduce their consumption as opposed to the permanent income hypothesis. This is due to numerous extensive dynamic factors that influence consumptions. Besides, people have varying priorities that aid in defining their expenditure. For instance, we would expect low-income families with low liquidity to increase consumption on the increament. However, some have to offset loans, save for the future as well as fulfil a leisure activity promised to their children on their birthday. These variations increase the margin error likely to occur in prediction of changes in tax. North-Holland: Elsevier. Blundell, R. , Pistaferri, L. , & Preston, I. Consumption Inequality and Partial Insurance,American Economic Review, vol. 2, no. 1, pp. Johnson, D. S. , Parker, J. D. , & Slemrod, J.

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