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True/False Consumption is positively related to stock market wealth but negatively...

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lilylee | Student, College Freshman | (Level 1) Salutatorian

Posted June 17, 2013 at 1:00 PM via web

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True/False

Consumption is positively related to stock market wealth but negatively related to taxes and tax rates.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted June 17, 2013 at 1:38 PM (Answer #1)

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This statement is true.

We can say that consumers have three choices about what to do with their money.  They can use it for consumption.  That is, they can spend it to buy goods or services.  Second, they can save it.  Finally, they can pay it to the government in taxes. 

Given these three choices, it is easy to see why consumption is negatively related to taxes and tax rates.  If people are having to spend a great deal of their money to pay taxes, they will have less of it to spend on consumption.  The same will be true if they worry that tax rates will rise in the near future.

Consumption is positively related to stock market (and all other) wealth.  If you are rich because you own a lot of stocks and the stock market is doing well, then you will not feel as much of a need to save when you get more money.  You will already feel that you are rich enough and will choose to spend rather than to save.

Stock market wealth allows us to spend our marginal income, thus increasing consumption.  Taxes take income away from us and therefore reduce consumption.  Therefore, the statement is true.

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