Real incomes measure the amount of disposable income available to consumers (eg, households & individuals).

Factors impacting real incomes:

  • inflation
  • wage growth
  • employment levels
  • interest rates
  • tax policies

Household income is only one factor that impacts consumer spending.

Impacts of lower interest rates

  • Costs of servicing loans / debt is reduced—boosting spending power
  • Consumer confidence should increase leading to more spending
  • Effective disposable income rises—lower mortgage costs
  • Business investment should be boosted eg, prospect of rising demand.
  • Housing market effects - more demand and higher property prices
  • Exchange rate and exports - cheaper currency will increase exports

Impacts of higher interest rates

  • Cost of borrowing rises
  • Main effect will be through mortgages
  • Add contraction in retail credit
  • Repayments on other debts
  • Possible slowdown in housing market
  • Higher rates might also cause currency to get stronger
  • Makes UK exports more expensive in overseas markets

Demographic Factors

Demography is concerned with the size and composition of a population. Changes in population dynamics occur slowly but can be significant for business.

Practice Exercise 2

  1. Explain terms
    • interest rates—the reward for saving or the cost for borrowing
    • market conditions—factors that impact the market a business is operating in
    • demographic factors—the makeup of the population that the business is operating in
    • environmental issues - whether a business can operate in an environmentally friendly way.
  2. Competition will split customers in the market between the competing businesses—this will reduce the revenue of individual businesses, and require them to adapt and outwit their competition to become dominant. This will increase the costs of the businesses. Equally, the demand for goods or services provided in the market will likely increase due to marketing campaigns, however the demand for a specific business’s services may decrease if they are not successful in their marketing efforts.
  3. If the average income of the population is decreasing in terms of value (not necessarily numbers), then the amount of disposable income people have will decline. This will result in less money being spent on non-essential or luxury items—causing these businesses to suffer from reduced revenue. Additionally, it will increase the chance of people opting for cheaper products when they have multiple options. So lower income will reduce the demand for luxury items, which will in turn reduce the revenue of businesses producing such items.
  4. If interest rates decline, then people with debts or mortgages will have less to pay back, and will therefore have more disposable income. This will lead to greater consumer spending. However, the long-term implication of this is that people saving will be making lower returns on savings—resulting in possible economic issues for them in future. If people were on a tighter budget before interest rates dropped, they may now have more money available to spend—resulting in an increased demand for luxury items and/or services. It is also possible that the demand for very cheap items will fall off—because people will be willing to spend their money on quality.
  5. If a business relies on borrowing money or trade credit to function, then higher interest rates will increase the amount that the business has to pay back on these borrowings. This will directly impact the costs of the business, and will possibly force the business to restructure their finances. Higher interest rates will also impact the customers that the business relies on to generate revenue, possibly forcing them to spend less or move to cheaper competitors. So when interest rates are high, it becomes important to consider costs to their customers, as if they are charging too much they may experience a sharp decrease in sales.