ChainWhat it assumes · how to break it
Start
Consumer confidence falls sharply as households fear for their jobs, as during the 2008 financial crisis.
1
As a result, households save more as a precaution against losing their jobs, so the saving ratio rises.
saving ratio · precautionary saving
saving ratio · precautionary saving
Assumes: Households can afford to save more.
But: Low-income households with no spare income cannot raise saving, so the effect is concentrated among better-off households.
2
This means consumption falls, particularly on big items bought on credit such as cars and furniture, so aggregate demand shifts to the left.
consumption · aggregate demand
consumption · aggregate demand
Assumes: Consumption is a large share of AD.
But: Consumption is over half of UK GDP, but if government spending or exports rise at the same time, AD may not fall.
3
Consequently, firms selling discretionary goods and services, such as cars, furniture, restaurants and holidays, see sales fall most, because demand for them is income and confidence elastic.
income elasticity of demand (YED) · luxury goods
income elasticity of demand (YED) · luxury goods
Assumes: The fall in spending is concentrated on discretionary goods.
But: Spending on necessities such as food and energy falls little, so firms selling them keep their workers.
4
This means these firms' derived demand for labour falls, so they freeze hiring and cut hours, temporary staff and jobs.
derived demand for labour
derived demand for labour
Best link to attack
Assumes: Firms cut labour rather than wait.
Assumes: Firms cut labour rather than wait.
But: Firms that think the fall in confidence will pass may hoard labour, especially skilled staff who are costly to replace.
5
Therefore, cyclical unemployment rises, and rising unemployment can lower confidence further, creating a downward spiral.
cyclical (demand-deficient) unemployment
cyclical (demand-deficient) unemployment
Assumes: Job losses feed back into lower confidence.
But: Government job support and automatic stabilisers can break the spiral by protecting incomes.
End
Employment falls and cyclical unemployment rises, especially in sectors selling discretionary goods.
Evaluation chain
- E1However, the rise in unemployment depends on firms cutting labour quickly rather than hoarding it.
- E2Because recruiting and training staff is costly, firms that expect confidence to recover within months will keep workers and cut hours or overtime instead.
- E3As a result, employment falls with a lag and by less than output, and the self-fulfilling spiral may not start.
- E4So a short dip in confidence may cost few jobs, while a lasting fall leads firms to cut jobs and pushes unemployment up.
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Questions this answers
- Assess the likely impact of a fall in consumer confidence on unemployment.
- Explain why a fall in consumer confidence may affect some industries more than others.
- Discuss how a fall in confidence can become self-fulfilling.
Diagram
AD/AS diagram with AD shifting left and real output falling, linked to the fall in derived demand for labour.
Reverse and related
Rise in consumer confidence → spending on discretionary goods rises, firms hire more and unemployment falls.