Consumption (economics)

Understanding Consumption in Economics

Consumption is a fundamental concept in economics, representing the use of resources to meet current needs and desires. But what exactly does this mean? Is it just about buying goods and services, or does it encompass more?

The Nature of Consumption

Consumption can be seen as a complex interplay between present needs and future planning. Mainstream economists often view consumption through the lens of final purchases of newly produced goods and services. However, others broaden this definition to include non-marketing economic activities that contribute to overall well-being.

The Consumption Function

Economists delve into the relationship between consumption and income using the consumption function. This model helps us understand how changes in income affect spending. The Keynesian consumption function, an absolute income hypothesis, assumes that future income doesn’t matter much. But this theory has faced criticism and modifications from alternative theories like Milton Friedman’s permanent income hypothesis and Franco Modigliani’s life cycle hypothesis.

Behavioral Economics and Consumption

Behavioral economics takes a different approach by incorporating principles of human behavior, such as bounded rationality, willpower, and selfishness. This field studies how these factors influence consumption decisions, providing insights that go beyond traditional economic models.

The Role in Aggregate Demand

Consumption is not just about individual spending; it’s a key component of aggregate demand. Microeconomics looks at consumer choice through utility functions and budget constraints, while behavioral economics highlights the impact of factors like popularity and position in a supermarket on purchasing decisions.

Theories Explaining Consumption

Economists have developed various theories to explain consumption patterns. The Absolute Income Hypothesis by Keynes suggests that higher income leads to increased consumption. Duesenberry’s Relative Income Hypothesis posits that people compare their incomes with others, influencing their spending habits. Milton Friedman’s Permanent Income Hypothesis and Franco Modigliani’s Life Cycle Hypothesis offer alternative perspectives on how permanent and future income affect consumption.

The Demonstration Effect

A key concept in these theories is the demonstration effect, which describes how people are influenced by others’ consumption patterns. This phenomenon can lead to sticky consumption levels even when incomes decline, as individuals resist reducing their spending habits they have become accustomed to over time.

Intertemporal Consumption

The model of intertemporal consumption helps us understand how consumption is distributed across different periods in a person’s life. John Rae first proposed this idea in the 1830s, and Irving Fisher expanded on it in the 1930s. The basic two-period model shows that savings (S) are equal to income minus consumption (Y – C).

Permanent Income Hypothesis

Milton Friedman’s Permanent Income Hypothesis divides income into transitory and permanent components, suggesting that changes in these components have different impacts on consumption. If permanent income increases, so does consumption.

Life-Cycle Hypothesis

The life-cycle hypothesis proposes that people distribute their consumption over their lifetime based on past, current, and future incomes. This theory uses the equation C = 1/T × W + 1/T × (R × Y), where C is annual consumption, T is years of life, R is working years, and Y is average wage.

Access-Based Consumption

A modern trend in consumption is access-based consumption. People increasingly seek the experience of temporarily accessing goods rather than owning them. This idea was put forward by social theorist Jeremy Rifkin in his 2000 publication, The Age of Access.

Old-Age Spending Patterns

In Western societies, there’s a growing trend where older people spend their money on travel, cars, and property instead of leaving it to their children. Studies show that many are prioritizing personal enjoyment over inheritance. For instance, 20% of married Americans consider leaving inheritance a priority, while 34% do not.

Conclusion

Consumption is more than just buying goods and services; it’s about meeting current needs and desires in the context of future planning. Understanding consumption helps us grasp economic behaviors and trends that shape our world. As we continue to evolve, so too will our understanding of what drives consumption.