The rule that total spending equals total income is very important, but only true for the economy as a whole. It is not true for individual households, businesses or sectors of the economy. Here, we consider a household.
Clearly, a household can choose to spend an amount different than its income.
Some of the income will go to taxes. The amount left over is called ‘disposable income’.
The household can use its disposable income for consumption or saving.
Consumption is a form of spending. It involves the purchase of goods and services.
Saving is defined simply as the act of not consuming. It is that part of disposable income not consumed.
If the household leaves some of its income in a savings account at a bank, this income is not consumed but saved.
Or the household might purchase some shares or bonds. Since shares and bonds are not goods or services, buying them does not count as spending, and so does not create income. Rather, holding shares or bonds are different ways of saving.
Some of the household’s income might be used to pay off debt, such as principal and interest on a home loan. This also counts as saving, because it is income not spent on goods and services.
So, part of income goes to taxes. Part can be consumed. And the rest will be saved.
It is also possible for a household to spend more than its income. There are two ways this can happen:
- Savings of an earlier period can be spent this period.
- Private borrowing.
When a household spends more than its income, its saving will be negative. This is called dissaving.