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Money, Banking and Households: Question 4

Syllabus 3.2

Multiple choice 1 mark

A national survey in the country of Karsova shows that, over the past year, a growing share of households now believe their jobs are secure and expect the economy to keep growing. Household income and the rate of interest have not changed over this period.

Assuming this rise in household confidence is the only change taking place, what is the most likely combined effect on household spending and household saving?

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Worked solution

Step 1: Identify what confidence actually changes

Household confidence is a separate influence on spending and saving from income and the rate of interest, both of which the question states are unchanged. When households feel more secure about their jobs and more optimistic about the future, they see less need to hold back money “just in case” (that is, less need for precautionary saving) and are more willing to spend on things they might otherwise have put off.

Step 2: Work out what must happen to saving

Since household income has not changed, whatever a household does not spend is saved, and whatever it does not save is spent, spending and saving cannot both rise or both fall out of the same fixed income. Rising confidence pushes households toward spending more, so, with income fixed, saving must fall to make up the difference.

Step 3: Rule out the other options

  • Option B (spending falls, saving rises) describes the response to a rise in the rate of interest, not to a rise in confidence. A higher interest rate rewards saving, but nothing here says interest rates have changed.
  • Option C (both rise) is impossible with income unchanged, since spending and saving must add up to income; if one rises, the other must fall.
  • Option D (both fall) would require income itself to fall, which the question rules out, and also contradicts the direction confidence is known to push spending.

Final answer

With income and interest rates unchanged, a rise in confidence encourages households to spend more of their income and worry less about a “rainy day”, so spending rises and saving falls, option A.