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CONSUMPTION
 

 

by Valentino Piana (2001)

 
     
 
 

Contents


 
 
1. Significance
 
 
2. Composition
 
 
3. Determinants
 
 
4. Impact on other variables
 
 
5. Long-term trends
 
 
6. Business cycle behaviour
 
 
7. Data
 
 
8. Empirical analyses
 
 
9. Formal models
 
 
An evolutionary microfoundation of consumption
 
 
 
 

Significance

Consumption is the value of goods and services bought by people. Individual buying acts are aggregated over time and space.

Consumption is normally the largest GDP component. Many persons judge the economic performance of their country mainly in terms of consumption level and dynamics.

Composition

First, consumption may be divided according to the durability of the purchased objects. In this vein, a broad classification separates durable goods (as cars and television sets) from non-durable goods (as food) and from services (as restaurant expenditure). These three categories often show different paths of growth.

Second, consumption is divided according to the needs it satisfies. A commonly used classification identifies ten chapters of expenditure:

1. Food
2. Clothing and foot wear
3. Housing
4. Heating and energy
5. Health
6. Transport
7. House furniture and appliances
8. Communication
9. Culture and schooling
10. Entertainment

People in different position in respect to income have systematically different structures of consumption. The rich spend more for each chapter in absolute terms, but they spend a lower percentage in income for food and other basic needs. The percentage values of an aggregation over all the households in a country can thus be used for judging income distribution and the development level of the society.

The rich have both higher levels of consumption and savings. In differentiated product markets, the rich can usually buy better goods than the poor. This happens also because they tend to use different decision making rules. In other words, consumption depends on social groups and their behaviours, as well as their proneness to advertising.

Third, one should distinguish "consumption" as use of goods and services from "consumption expenditure" as buying acts. For durable goods this difference may be relevant, since they are used for long time periods.

In this vein, the rich have a much wider cumulative bundle of durable goods purchased over time, so they enjoy a very significantly higher degree of need satisfaction, whereas the poor can suffer deficiencies even in the most basic goods.

Conversely, purchased non-durable goods that are not consumed before the deadline are a typical waste (and squander).

Fourth, only newly produced goods enter into the definition of consumption, wheareas the purchase of, say, an old house is not considered consumption in macroeconomics, since it was already counted in the GDP of the year in which it was built. Needless to say, for the consumer, both old and new goods provides some need satisfaction.

In microeconomic terms, total consumption expenditure of one household is the sum, across all categories, of the value (i.e. price times quantity) of all varieties of goods and services purchased, where the quantity purchased depends on the consumption average dose times the number of consumption occasions (i.e. seized consumption opportunities). Macroeconomic consumption is the sum of the consumption of all households, keeping into account that households are not independent from each other but rather communicate and co-variate.

Conversely, consumption is the value of domestic and foreign firms' sales in the domestic market to households (thus excluding business investment and public expenditure).

Determinants

Current income level and dynamics is the most relevant determinant of consumption. Income comes from labour (employment and wages), capital (e.g. profits leading to dividends, rents, etc.), remittances from abroad. Income from consumer's cumulative bundle (including dividends and interests on wealth) provides an additional flow to available income.

Cumulated savings in the past can be squeezed in case of necessity and give rise to a jump in consumption, similarly with what happens with wealth increase, due for instance to stock exchange boom or house prices boom. Family debt can be boosted to fund consumption, while repayments brake its dynamics.

Expectations on future income, especially if concerning short-term credible events, may also play an important role.

At household level, there are many possible rules set to control monthly, weekly or even daily consumption expenditure, resulting from empirical and theoretical approaches to consumers. These routines relate not only to income but also to the following factors among others:

1. general lifestyles, in particular attitudes toward savings or consumption and shopping as "values" in itself;
2. a standard level of consumption the family tries to maintain over time;
3. decisions regarding active saving strategies, like an investment scheme for pension aims;
4. the relative success of past investment in shares or other financial instruments; in fact, a housing, a real estate or a stock-exchange boom are likely to promote an euphoria tide with growing consumption;
5. opportunities of consumer credit, depending in turn by interest rates and marketing strategies by banks and special consumer credit institutions;
6. past decisions on durables. For instance, a family having bought a car will reduce expenditure on public transport in favour e.g. of fuel;
7. status symbols diffusion - "social musts" - that can be favoured by a pro-diffusion-of-innovation tax ;
8. new employment perspectives, also as far as the corresponding investments in human and physical capital are concerned;
9. innovative sale proposals in terms of both new products and new services, effectively advertised;

10. temporary money (cash) excess;
11. family debt management, with repayments tightening consumption;
12. fiscal conditions, with particular tax and subsidies impacting the timing and the amount devoted to purchases; VAT expected increases, for instances, might lead to anticipation to purchases.

According to age of the decision-maker, individual and household consumption varies, both in values and composition. Thus, aggregate consumption may be influenced by demographic factors, such as an older and older population, even though one should not rely too much on these relationships since demographic variables are extremely slow in changes, whereas consumption clearly reacts to economic climate.

Other things equal, a higher price level (inflation) reduces the real current income, thus real consumption.

Impact on other variables

A GDP component as it is, consumption has an immediate impact on it. An increase of consumption raises GDP by the same amount, other things equal. Moreover, since current income (GDP) is an important determinant of consumption, the increase of income will be followed by a further rise in consumption: a positive feedback loop has been triggered between consumption and income.

An autonomous increase of consumption, if at the same level of income, would reduce savings, but the positive loop just described (known as the "Keynesian multiplier") will imply an increase of income level with a positive impact on future savings.

If directed to goods and services produced abroad, an increase of consumption will immediately push up imports, while a similar indirect effect will result from consuming domestic products requiring foreign raw materials, energy, semi-manufactured goods.

Since usually the States separately tax consumption (say with a VAT tax), an increase of consumption will also boost this type of State revenue, as well as import duties revenue in the case of imported goods. The growth mechanism of consumption-income will also provide State revenue through income taxes.

To the extent firms decide to invest by forecasting future demand and by comparing it with present production capacity, an increase of consumption may induce new investment. In particular:

1. soaring consumption raises the production capacity utilization, with positive effects on profits;
2. it improves expectations on future demand;
3. it improves the financial conditions for funding investment both through profits and loans.

If exports are a second-best solution for domestic firm, an increase of domestic consumption might decrease export, since at the same level of production firms would prefer to sell inside the country. To verify this by yourself, try and play "You are an exporter".

Consumer dissatisfaction with current products can lead to faster adoption of new products, thus intertwining the whole new product development cycle.

An increased total market demand may induce firms to increase prices, the more so when they operate at full production capacity or they operate on monopolized markets. Thus increased price level and accelerated inflation can be an effect of booming consumption.

Consumption can lead to CO2 emissions in the atmosphere, thus contributing to climate change.

Long-term trends

In Western countries, consumption has always grown in the last 50 years, except in few deep recessions. Its growth is smoother than investment's rise or net exports' growth. In particular, services have always systematically grown at a fairly steady pace, non-durables have often mirrored the business cycle and durables have often over-shot the fluctuations in GDP.

Sustainable lifestyles, based on satisfaction of basic needs, green consumer goods, dematerialisation, and carbon footprint off-setting, will be more and more relevant in the future.

Business cycle behaviour

As the main component of GDP, it is pro-cyclical almost by definition: any large fall in consumption would reduce GDP. Consumption has a smoother dynamics than GDP. During a recovery, it sustains and stabilises the trend. Durable goods, however, are strongly pro-cyclical and they may peak shortly before GDP.

Particular tax reductions and subsidies can be directed to temporarily sustain sales in order to promote extraordinary purchases. If large enough, they may help in economic turn-around from recession to recovery. Cars and house-related large expenditures have been often targeted, with green goods possibly engendering further benefits to climate change mitigation.

Data

Consumption and the other GDP components (1946-2007) for 171 countries

Consumption data from 136 countries: a long term time series
Consumption expenditure by income classes

93 Food products prices in 198 countries
Data for all the variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)
Savings behaviors in the UK population (2000 and 2001)
Coffee world prices (1982 - 2000)
Consumer micro-decisions database

Empirical analyses

Experiment with real consumers about "sustainable coffee" price premium

Fair Trade coffee hedonic price in Italy

Changing patterns of households consumption in India (2004)

A behavioral model of cyclical food dieting

Durable goods during the 2010 business cycle

Formal models

Consumer choice in the neoclassical model for microeconomics

Consumer decision rules for agent-based models

An interactive map of how consumption is related to the rest of the economy according to a basic macroeconomic scheme: the IS-LM model

Develop your own skills in demand forecasting of durable and non durable goods through a computer-aided simulation

Consumers' choice in front of differentiated products: a business model simulation

Consumption in the economics of ex ante coordination

Does job impacts on consumption habits?

A behavioral model of consumption patterns: the effects of cognitive dissonance and conformity

 

 
 
 
 
Key concepts
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