IGCSE Economics 0455: How Income Affects Household Saving

Fatou works as a nurse and currently earns a monthly income of $1800. She spends $1600 of this each month and saves the remaining $200. Fatou has just been offered a promotion that would raise her monthly income to $2400, and she plans to keep her monthly spending fixed at $1600 if she takes it.

(a) Calculate Fatou's monthly saving as a percentage of her monthly income, both before and after the promotion. Give each answer correct to 1 decimal place. [2]

(b) Using Fatou's figures from part (a), explain why a rise in income tends to increase the amount a household saves. [2]

(c) Fatou is also considering taking out a bank loan now to buy a car, rather than waiting until she has saved enough to buy it outright. Explain one reason why her higher income might make both Fatou and the bank more willing to go ahead with this loan now. [2]

Part (a): Fatou’s saving rate before and after the promotion

Before the promotion, Fatou saves $200 out of a monthly income of $1800. As a percentage of income: $\frac{200}{1800} \times 100 = 11.111...$

Rounded to 1 decimal place, this is $11.1\%$ of her income.

After the promotion, her income rises to $2400 while her spending stays fixed at $1600, so her monthly saving becomes: $2400 - 1600 = 800$

As a percentage of her new income: $\frac{800}{2400} \times 100 = 33.333...$

Rounded to 1 decimal place, this is $33.3\%$ of her income.

Part (b): Why a rise in income increases saving

Fatou’s spending does not change at all when her income rises. It stays fixed at $1600 in both cases. This means the entire $600 increase in her income (from $1800 up to $2400) ends up as extra saving, taking her saving from $200 to $800 and her saving rate from $11.1\%$ to $33.3\%$ .

This illustrates a general pattern: households rarely increase their spending by the full amount of a rise in income, so whatever is not spent is saved instead. The larger the rise in income relative to the rise in spending, the larger the increase in both the amount and the proportion of income that is saved.

Part (c): Why higher income makes the loan more likely

A bank lending money, and a borrower taking on a loan, both care about whether the loan can be comfortably repaid. Fatou’s higher income of $2400 a month, compared with $1800 before, means the fixed monthly repayments on a car loan take up a smaller share of her income and leave more left over for her other spending and saving.

This works two ways: the bank sees a borrower with more disposable income and a bigger buffer against unexpected costs, so it is more confident she will keep up with repayments and more willing to approve the loan; and Fatou herself feels more confident that she can afford the repayments without financial strain, so she is more willing to borrow now rather than wait until she has saved the full price of the car.

Final answers

(a) Before the promotion: 11.1% of income saved ($200 of $1800). After the promotion: 33.3% of income saved ($800 of $2400).
(b) Since spending is unchanged, the whole rise in income becomes extra saving, increasing both the amount and proportion of income saved.
(c) A higher, more secure income increases Fatou’s ability to repay the loan and the bank’s confidence that she will do so, making both parties more willing to agree to the loan now.