DIVIDED LIVES,

DIVIDED COSTS:
THE UNEQUAL
IMPACT OF THE
COST OF LIVING
Word Count: 733

Erasmus, LA, Mr [24897647@sun.ac.za]

| Economics 214
Table of Contents
INTRODUCTION ..................................................................................................................................................2

LIMITED ACCESS TO FINANCIAL BUFFERS..............................................................................................2

LARGER SHARE OF SPENDING ON ESSENTIALS .....................................................................................2

SENSITIVITY TO PRICE SHOCKS ..................................................................................................................3

EXCESS DEBT BURDENS. .................................................................................................................................3

CONCLUSION.......................................................................................................................................................3

BIBLIOGRAPHY ..................................................................................................................................................4

1
Introduction
The economic climate is characterised by rising prices for essential goods and services and a
concomitant erosion of purchasing power. This confluence has come to be known as the cost
of living crisis. The term “crisis” implies universality in its impact, however a critical dissection
reveals disparities exist across the income distribution. Because higher income groups are more
insulated from its impact, this research will argue that the crisis disproportionately affects low
income households due to (1) their limited access to financial buffers, (2) the higher proportion
of their spending on essential goods, (3) their sensitivity to price shocks and (4) excess debt
burdens.

Limited Access to Financial Buffers

Low income households face challenges in acquiring financial buffers, such as savings,
investments or access to credit. With income often unable to cover basic necessities there is
little room for surplus funds. Exclusion from mainstream financial services limit the size of
low income households financial safety net and without these buffers in place, poorer
households are forced to make difficult trade-offs that make them exceptionally vulnerable to
the cost of living crisis. Research by Mullainathan and Shafir on low income household saving
decisions support this notion and highlight the role that limited “buffer stock savings” and
“financial slack” play on the ability for poorer individuals to optimally smooth their
consumption (2009: 129,132). Additionally, a South African study strengthens this work of by
displaying that low income households with no access to credit exceeded the non-poor by more
than 6% in the first year and more than 12% in final year of research (Okurut, 2006: 7).

Larger Share of Spending on Essentials

Another factor that exasperates the effect of the cost of living crisis on low income households
is their disproportionately larger share of spending on essential goods, such as housing, utilities
and food. This economic phenomenon is known as Engels law. Engels law loosely dictates an
inverse relationship between income and the proportion of income spent on essentials. This
understanding translates to following quote “the greater is the proportion of the total outgo which
must be used for food (Pope, 2012: 6). The combination of a lack of financial buffers alongside
the large proportional spending of income on essentials further tightens low income groups
budgets, making them more susceptible to the price shocks discussed in the subsequent section.

2
Sensitivity to Price Shocks
As discussed, the cost of living crisis disproportionately affects low income households. A
central explanation for this is sensitivity to price shocks. Elaborated, low income households
characterised by the above mentioned minimal access to financial buffers and larger
proportional spending on essentials, have less capital to adjust to significant price changes or
shocks. A study done on the effects of petrol price shocks on food security confirmed this
theory, whereby positive petrol price shocks increased the “probability of needing more money
in the low income sample” but had “no significant effect” for the higher income group (Beatty
& Tuttle, 2017: 16). The occurrence of price shocks subsequently results in reduced purchasing
power, less capital for essentials and even less to contribute towards a financial buffer, further
intensifying the effects of the cost of living crisis.

Excess Debt Burdens.

Another reason for the sensitivity of low-income households to the cost of living crisis
compared to higher income groups is due to the burden of existing debt. A study undertaken
by Hafizah Binti Hammad Ahmad Khan demonstrates a concerning correlation : that a rise in
the cost of living will “indirectly affect the household ability to fulfil their debt repayment due
to a decline in their real income” (2017: 173). Another contribution of this study suggests that
increases in the cost of living may lead to “stricter lending policies by the banks” in order to
reduce low confidence borrowing (2017: 217). Relating back to the notion of limited access
to financial buffers, this study suggests that limited access to credit may encourage informal
lending and exasperate the cyclical nature of the crisis, plummeting low income groups further
into debt.

Conclusion
As evident by the findings presented, the cost of living crisis is indeed not a universal
phenomenon, but a targeted attack on low income households. The financial restrictions
associated with low income households including lack of financial buffers, large proportional
spending on essential goods, sensitivity to price shocks and existing debt burdens, all
disproportionately exasperate the impact of the cost of living crisis.

3
Bibliography

Khan, H.B.H.A. 2017. The effects of cost of living and household dependency on household
debt and its composition in Malaysia. School of Economics, Finance and Banking: 1-265

Mullainathan, S. and Shafir, E. 2009. Savings policy and decision-making in low-income

households. Insufficient funds: Savings, assets, credit, and banking among low-income
households, 121: 40-142.

Okurut, F.N. 2006. Access to credit by the poor in South Africa: Evidence from Household
Survey Data 1995 and 2000. Department of Economics, University of Botswana Stellenbosch
Economic Working Papers, 13(06): 1-34

Pope, R. 2012. Engel's Law. BYU Studies Quarterly, 51(3): 119-140.

Tuttle, C. and Beatty, T.K. 2017. The effects of energy price shocks on household food security
in low-income households.