Question

In what direction will each of the following occurrences shift the consumption and saving schedules, other things equal? LO30.2 a. A large decrease in real estate values, including private homes. b. A sharp, sustained increase in stock prices. c. A 5 -year increase in the minimum age for collecting Social Security benefits. d. An economywide expectation that a recession is over and that a robust expansion will occur. e. A substantial increase in household borrowing to finance auto purchases.

Short answer

a) Shift: consumption down, saving up. b) Shift: consumption up, saving down. c) Shift: consumption down, saving up. d) Shift: consumption up, saving down. e) Shift: consumption up, saving down.

Step-by-step solution

Analyze the Decrease in Real Estate Values

When real estate values decrease significantly, homeowners may feel less wealthy. This might lead to a decrease in consumption because they perceive a reduction in their overall wealth. As people consume less, they might save a bit more to compensate for the loss in perceived wealth. Therefore, the consumption schedule will likely shift downward and the saving schedule upward.

Examine the Increase in Stock Prices

A sharp increase in stock prices makes stockholders feel wealthier. Consequently, individuals might increase their consumption, believing they have more assets to fall back on. Hence, the consumption schedule will likely shift upward while the saving schedule may shift downward since people might feel less need to save.

Assess the Increase in Minimum Age for Social Security Benefits

Raising the minimum age for Social Security benefits may lead people to save more for retirement, as they need personal savings to cover their needs until they can draw benefits. Therefore, the saving schedule would likely shift upward and the consumption schedule downward due to increased saving efforts.

Evaluate the Expectation of Economic Expansion

If people believe a robust economic expansion is forthcoming, they may feel more secure in their financial future. This confidence could prompt an increase in current consumption, shifting the consumption schedule upward and the saving schedule downward, as people may feel less need to save.

Consider the Increase in Household Borrowing for Auto Purchases

A substantial increase in borrowing suggests that households are financing more consumption (autos in this case) with borrowed funds. This will shift the consumption schedule upward as people are buying more durables, and may also shift the saving schedule downward since increased borrowing might imply less saving.

Key concepts

Real Estate Values Effect

When real estate values decline, it impacts how wealthy homeowners feel. This is because a significant asset they own is now worth less. A dip in perceived wealth can change consumer behavior. Homeowners might decide to cut back on spending, as they feel the need to conserve their financial resources. This results in a shift of the consumption schedule downward, meaning people are spending less on goods and services.
At the same time, feeling less wealthy might encourage individuals to save more of their income to rebuild their net worth. This leads to an upward shift in the saving schedule.

• Decrease in consumption due to lower perceived wealth.
• Increase in savings as a compensatory measure.

Stock Prices Impact

A sharp rise in stock prices can significantly affect individuals’ perceptions of their wealth. Stockholders, experiencing an increase in the value of their investments, tend to feel more financially secure and affluent. This perceived increase in wealth often encourages people to spend more, thereby shifting the consumption schedule upward.
On the flip side, since they feel richer, they might choose to save less, relying on their increased asset values. Consequently, the saving schedule shifts downward because people are using their perceived wealth as a buffer instead of saving income directly.

• Increased consumption due to perceived wealth gain.
• Decreased savings because of reliance on asset wealth.

Social Security Benefits Age

When the minimum age for collecting Social Security benefits is raised, it directly impacts retirement planning. People realize that they will need to cover their expenses for more years before they can access these benefits. As a result, individuals are likely to increase their personal savings during their working years, leading to an upward shift in the saving schedule.
This heightened saving effort often comes at the cost of current consumption, which decreases. People spend less on discretionary purchases as they prioritize building a larger nest egg for later, resulting in a downward shift in the consumption schedule.

• Increased savings due to extended benefit delay.
• Decreased consumption as savings take priority.

Economic Expansion Expectations

Economic optimism can powerfully influence consumer behavior. When people expect the economy to expand robustly, they tend to feel more confident about their financial stability and future prospects. This elevated confidence can lead to an uptick in spending, as consumers may anticipate stable or increasing future incomes, leading to an upward shift in the consumption schedule.
With greater confidence in the economy, individuals might feel less compelled to save, expecting that their economic situation will improve anyway. This may shift the saving schedule downward, with present needs and desires taking precedence over future security.

• Increased consumption due to economic optimism.
• Decreased savings as future economic confidence increases.

Household Borrowing

When households increase borrowing, especially for significant purchases like automobiles, it usually affects consumption and savings. Borrowing enables families to buy goods and services they might not afford otherwise, leading to an upward shift in the consumption schedule since spending on durable goods increases.
However, borrowing more can indicate that households are saving less, perhaps using borrowed money to meet current needs. This reliance on credit rather than saved cash could drive the saving schedule downward, as present consumption is prioritized over long-term financial health.

• Increased consumption due to higher borrowing.
• Decreased savings because of reliance on credit.