CHAPTER 4
THE CONSUMER IN OUR ECONOMY
Overview
As you read this chapter, look for answers to the following questions:
• What are the sources of personal wealth?
• How do personal budgets, banks and other financial institutions, consumer credit, and insurance
plans help you use your money wisely?
• What are some techniques advertisers use to sell their products, and how can you make wise
consumer choices?
• How do governments and private agencies protect consumers?
4.1. Your Role as a Consumer
Take a few minutes to add up the money you spend in a month on tapes and CDs, hamburgers and fries, new shoes and clothes, movies, and other "necessities." You might be surprised to discover just how much money you and your friends spend and contribute to the economy, Across the nation teenagers spend an average of almost $60 billion each year!
4.2. We Are All Consumers
A consumer is anyone who buys goods or services for personal use. At one time or another, everyone is a consumer.
Consumer spending is the largest sector of the economy. In 1993, for example, consumer spending totaled more than $4 trillion, or nearly 70 percent of the GDP that year. For that reason, even small changes in the level of consumer spending can have a profound effect on the economy as a whole.
As a consumer you are affected by scarcity. Your wants are greater than the resources needed to satisfy them. Therefore, you must make decisions about how to use your resources. The very first questions you must answer are: "What goods and services will I buy?" and "How much of my income will I set aside in savings?"
Before you can buy or save anything, you must earn the money. There are two ways to earn income -from your work and from the use of your wealth.
Median Monthly Earnings by Job Category, 1993
4.3. The Sources of Income
Income From Work. Most of the income you are likely to earn will come from work. In return for working, you will receive a wage or salary. (The term "wage" typically refers to the earnings of workers paid by the hour or unit of production. "Salary" refers to earnings paid on a weekly or monthly basis.) How much you earn will depend on your job, your abilities, your performance, and several other factors. Table 4-2 summarizes the typical monthly earnings for a variety of jobs.
Over the next few years you will be entering the job market. When you do, the career you choose, the job you get, and the income you earn will be the result of the thought and effort you put into preparing for it.
Income From Wealth. Wealth can be expressed as the value of the things you own. Adding the value of all your possessions, bank accounts, savings, and investments will give you the total amount of your wealth.
Used in certain ways, wealth can earn income. If you own a motorcycle, you might be able to let others use it for a fee. Then economists would say that you are using your wealth to earn "rent." Wealth, in the form of money that is loaned to others or deposited in a savings account, will earn interest. Interest and rent are two forms of income that can be earned from wealth.
4.4. Saving
The Decision to Save. American consumers spend about 95 percent of their income and save the rest. Wealth, expectations, current interest rates, and tax laws all influence how much individuals and families will save.
• Wealth. Wealth, as you just read, is the value of things people own, such as cars, stereos, bank accounts, stocks, bonds, and real estate. Studies have shown that as income levels increase a typical household will save more.
• Expectations. When people think better times are coming, they tend to increase their spending and decrease their rate of savings. But if the future looks bleak, and people fear losing their jobs, they tend to postpone major purchases and investments and save more.
• Current Interest Rates. Rising interest rates promote savings. Attracted by higher returns, many consumers will choose to save rather than spend. Others, unable to afford the cost of borrowing, will postpone the purchase of higher-priced items such as cars, appliances, and homes until interest rates come down.
• Tax Laws. Government can use its power to tax to encourage or discourage savings. Raising taxes on income earned from savings discourages people from saving. Cutting taxes on savings encourages people to save.
Government also encourages savings by allowing individuals to use their savings to buy tax-free state and local government bonds. Individuals who invest in these bonds need not pay taxes on their earnings. Similarly, government encourages people to save for their retirement years through Individual Retirement Accounts (IRAs), which earn tax-free interest on long-term savings,
Most people wish they could save more money for education, a car, a home, and other major expenses. However, in the United States the pressure to spend your money now is tremendous. Advertising agencies work overtime and spend millions of dollars to create ads that will attract your attention. Many American businesses - like "Top 40" radio stations, clothing manufacturers, motion picture studios, and cosmetic companies - work hard to make products teenagers like you will buy. Nevertheless, many banks and other financial institutions are eager to help you save your money.
Saving Strategies.
"Enjoy the highest rates of interest with one of our passbook accounts..."
"Be sure to look into our CDs..."
"Why not consider a money market fund...?"
Have you noticed how many institutions would like to hold your savings? Almost daily you will hear a commercial or read an ad describing the advantages of one kind of savings program over another.
While you may have found these claims and counterclaims to be confusing, don't let them discourage you from starting a savings program. Saving is one of the most important things that you can do. By saving regularly, your family can get the things it wants and be prepared to deal with the unexpected -job loss, illness, and the uncertainties of old age.
What should you look for when you shop for a place to save?
Just as it pays to shop before making an important purchase, it also pays to shop for a place to save. Safety, Rate of Return, and Liquidity are factors to consider.
• Safety. Think about safety when you save money. You could hide your savings in your mattress or a desk drawer, but if you're smart you won't. They are the first places someone is likely to look. Banks and savings institutions, though, protect your money against fire theft, and other disasters.
Also, banks and savings institutions offer government-sponsored insurance that guarantees the safety of your savings up to $100,000. Other securities, however, are less safe. The stocks and bonds of private corporations can decline in value and, sometimes, become worthless.
• A Rate of Return. One of the main reasons to place your savings in a bank is to earn interest, the reward or return for allowing someone else (the bank) to use your capital. The rate of return is expressed as a percentage of the amount on deposit (the principal) for a period of one year.
For example, a deposit of $100 in an account paying 5 percent would earn a total of $5 in interest over a year. The $5 is the return; the rate of return is 5 percent ($5 : $100 = .05 or 5%).
Most
accounts offer compound
interest. This
is interest computed on the principal plus the previously paid
interest- assuming it is left in the account. The dramatic effects
of compounding are illustrated in Table .
The rate of return offered by banks and savings institutions will vary with economic conditions and the length of time they hold your money. It is also important to distinguish between rate of return and yield, the actual amount of interest earned. Yield depends on the rate of return and the frequency of compounding.
The First National Bank pays 8 percent, compounded quarterly (four times a year), on its savings accounts. The Second National Bank pays 8 percent annually. A $1,000 deposit in the First National would earn $82.43 by the end of the year, but the same amount deposited in the Second National would only earn $80. The rate of interest was the same at both banks but more frequent compounding at First National resulted in a yield that was $2.43 greater.
• Liquidity. Liquidity measures how easily you can convert your savings to cash. The easier it is to withdraw your funds, the greater the liquidity.
They were the skates he had wanted since he made the hockey team. And he was lucky; it was the last day of the sale. "All I have to do," he thought, "is take the money out of the bank, come back, and buy the skates." But his excitement quickly faded when he remembered it was Saturday. His bank would not open until Monday. When he told his story to one of his teammates, his friend said, "I know all about the skate sale. I bought a pair for myself." "How did you get the money?" asked the skateless one. "Simple," said the friend. "My bank has a cash machine. I can withdraw my money any time."
Liquidity has a price, however. The hockey player who used the automatic teller machine probably had to pay a service charge, and, in general, the easier it is to withdraw your money from a bank or savings and loan, the lower the interest rate the institution will pay.
The size of your income and your commitment to saving determines how much you, as a consumer, will have left to spend.