17. Households

Circular Flow of Income (Two-Sector Model)
The circular flow of income explains how money moves continuously between households and firms in a simplified economy. In this two-sector model, there is no government or foreign trade. Households supply firms with factors of production (land, labor, capital, and enterprise), and in return, firms pay factor incomes to households. The money households receive is then used to purchase goods and services from firms, completing the cycle.

Factor Incomes
Households receive different types of income based on the factors of production they provide:

• Land earns rent
• Labor earns wages
• Capital earns interest or rate of return
• Enterprise earns profit

These incomes represent the cost of production to firms and the earning of households.

Household Income and Expenditure
Income is the money individuals or households receive over a period. It includes salaries, wages, interest, rent, and profits. Disposable income refers to income left after paying taxes and receiving benefits. Expenditure is the spending of income on goods and services. It is influenced by several factors such as disposable income, wealth (assets like bank balances, shares, property), and the rate of interest.

Consumption
Consumption is the use of goods and services to meet current needs and wants. It differs from investment, which is aimed at future gains. Consumption is a central concept in economics and represents household expenditure on both durable and non-durable goods. It is a key component of aggregate demand and reflects overall economic health.

Average Propensity to Consume (APC)
This is the proportion of total income that is spent on consumption.

• APC = Consumption (C) / Income (Y)
  A higher APC suggests that households are spending more of their income, while a lower APC indicates more saving behavior.

Average Propensity to Save (APS)
This is the proportion of income that is saved rather than spent.

• APS = Saving (S) / Income (Y)
  Saving is important for financial stability and investment. APS reflects how households prioritize future needs over current consumption.

Spending Patterns
Spending patterns vary across income levels:

• Poor households spend a larger proportion of their income on basic necessities like food and clothing.
• Rich households, though they spend more in absolute terms, allocate a smaller percentage of their income to these essentials.
• Wealthier households spend more on luxury goods, consumer durables, entertainment, and services.
  These differences also exist between countries, where poor countries allocate more to necessities, while richer nations spend more on luxury and discretionary items.

Saving
Saving is the portion of income not used for immediate spending. It is often set aside for future use, emergencies, investments, education, or retirement. Factors influencing saving behavior include income level, interest rates, expectations about the future, inflation, and personal financial goals.

Borrowing
Borrowing allows individuals to use money now with the intention of repaying it in the future. It moves income from those who are not spending (savers) to those who need funds. People borrow for various reasons:

• To maintain living standards during a drop in income
• To finance major purchases such as cars or houses
• For education, healthcare, or holidays
• In expectation of increased future income
  Mortgages are common long-term loans used to purchase homes. Borrowing decisions are influenced by interest rates, credit availability, and income expectations.

The Multiplier Effect
The multiplier effect describes how an initial increase in spending results in a larger overall increase in income and output. For example, if a household spends more on goods, it increases demand, leading firms to produce more and hire more workers, who in turn spend more money. The size of the multiplier depends on the marginal propensity to consume (MPC); the higher the MPC, the larger the multiplier.