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Consumption is the act of using resources to satisfy current needs and wants. It is seen in contrast to
investing Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
, which is spending for acquisition of ''future'' income. Consumption is a major concept in economics and is also studied in many other
social sciences Social science is one of the branches of science, devoted to the study of societies and the relationships among individuals within those societies. The term was formerly used to refer to the field of sociology, the original "science of socie ...
. Different schools of economists define consumption differently. According to mainstream economists, only the final purchase of newly produced
goods In economics, goods are items that satisfy human wants and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not tr ...
and
services Service may refer to: Activities * Administrative service, a required part of the workload of university faculty * Civil service, the body of employees of a government * Community service, volunteer service for the benefit of a community or a p ...
by individuals for immediate use constitutes consumption, while other types of expenditure — in particular,
fixed investment Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time. Thus, fixed investment is the accumulation of physical assets such as machinery, lan ...
,
intermediate consumption Intermediate consumption (also called "intermediate expenditure") is an economic concept used in national accounts, such as the United Nations System of National Accounts (UNSNA), the US National Income and Product Accounts (NIPA) and the European ...
, and government spending — are placed in separate categories (see
consumer choice The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
). Other economists define consumption much more broadly, as the aggregate of all economic activity that does not entail the design, production and
marketing Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to empha ...
of
goods and services Goods are items that are usually (but not always) tangible, such as pens, physical books, salt, apples, and hats. Services are activities provided by other people, who include architects, suppliers, contractors, technologists, teachers, doc ...
(e.g. the selection, adoption, use, disposal and recycling of goods and services). Economists are particularly interested in the relationship between consumption and income, as modelled with the
consumption function In economics, the consumption function describes a relationship between consumption and disposable income. The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a ...
. A similar realist structural view can be found in consumption theory, which views the Fisherian intertemporal choice framework as the real structure of the consumption function. Unlike the passive strategy of structure embodied in inductive structural realism, economists define structure in terms of its invariance under intervention.


Behavioural economics, Keynesian consumption function

The Keynesian
consumption function In economics, the consumption function describes a relationship between consumption and disposable income. The concept is believed to have been introduced into macroeconomics by John Maynard Keynes in 1936, who used it to develop the notion of a ...
is also known as the
absolute income hypothesis In economics, the absolute income hypothesis concerns how a consumer divides their disposable income between consumption and saving. It is part of the theory of consumption proposed by economist John Maynard Keynes. The hypothesis was subject to ...
, as it only bases consumption on current income and ignores potential future income (or lack of). Criticism of this assumption led to the development of Milton Friedman's
permanent income hypothesis The permanent income hypothesis (PIH) is a model in the field of economics to explain the formation of consumption patterns. It suggests consumption patterns are formed from future expectations and consumption smoothing. The theory was develope ...
and
Franco Modigliani Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at University of Illinois at Urbana–Champaign, Carnegie Mellon Univ ...
's
life cycle hypothesis In economics, the life-cycle hypothesis (LCH) is a model that strives to explain the consumption patterns of individuals. Background The hypothesis Implications Saving and wealth when income and population are stable The effect of populatio ...
. More recent theoretical approaches are based on
behavioural economics Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...
and suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviourally-based aggregate consumption function. Behavioural economics also adopts and explains several human behavioural traits within the constraint of the standard economic model. These can range from: bounded rationality bounded willpower, and bounded selfishness. Bounded rationality was first proposed by Herbert Simon. This means that people sometimes respond rationally to their own cognitive limits, which aimed to minimize the sum of the costs of decision making and the costs of error. In addition, Bounded willpower refers to the fact that people often take actions that they know are in conflict with their long-term interests. For example, most smokers would rather not smoke, and many smokers willing to pay for a drug or a program to help them quit. Finally, bounded self-interest refers to an essential fact about the utility function of a large part of people: under certain circumstances, they care about others or act as if they care about others, even strangers.


Consumption and household production

Aggregate consumption is a component of
aggregate demand In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is ...
. Consumption is defined in part by comparison to
production Production may refer to: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production as a stat ...
. In the tradition of the Columbia School of Household Economics, also known as the
New Home Economics Gary Stanley Becker (; December 2, 1930 – May 3, 2014) was an American economist who received the 1992 Nobel Memorial Prize in Economic Sciences. He was a professor of economics and sociology at the University of Chicago, and was a leader ...
, commercial consumption has to be analyzed in the context of household production. The opportunity cost of time affects the cost of home-produced substitutes and therefore demand for commercial goods and services. The elasticity of demand for consumption goods is also a function of who performs chores in households and how their spouses compensate them for opportunity costs of home production. Different schools of economists define
production Production may refer to: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production as a stat ...
and consumption differently. According to mainstream economists, only the final purchase of
goods In economics, goods are items that satisfy human wants and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not tr ...
and
services Service may refer to: Activities * Administrative service, a required part of the workload of university faculty * Civil service, the body of employees of a government * Community service, volunteer service for the benefit of a community or a p ...
by individuals constitutes consumption, while other types of expenditure — in particular,
fixed investment Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time. Thus, fixed investment is the accumulation of physical assets such as machinery, lan ...
,
intermediate consumption Intermediate consumption (also called "intermediate expenditure") is an economic concept used in national accounts, such as the United Nations System of National Accounts (UNSNA), the US National Income and Product Accounts (NIPA) and the European ...
, and government spending — are placed in separate categories (See
consumer choice The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
). Other economists define consumption much more broadly, as the aggregate of all economic activity that does not entail the design, production and
marketing Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to empha ...
of
goods and services Goods are items that are usually (but not always) tangible, such as pens, physical books, salt, apples, and hats. Services are activities provided by other people, who include architects, suppliers, contractors, technologists, teachers, doc ...
(e.g. the selection, adoption, use, disposal and recycling of goods and services). Consumption can also be measured in a variety of different ways such as
energy In physics, energy (from Ancient Greek: ἐνέργεια, ''enérgeia'', “activity”) is the quantitative property that is transferred to a body or to a physical system, recognizable in the performance of work and in the form of heat ...
in
energy economics Energy economics is a broad scientific subject area which includes topics related to supply and use of energy in societies. Considering the cost of energy services and associated value gives economic meaning to the efficiency at which energy ...
metrics.


Consumption as part of GDP

GDP Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is ofte ...
(Gross domestic product) is defined via this formula: Y=C+G+I+NX Where C stands for consumption. Where G stands for total government spending. (including salaries) Where I stands for Investments. Where NX stands for net exports. Net exports are exports minus imports. In most countries consumption is the most important part of GDP it ranges usually ranges from 45% from GDP to 85% of GDP.


Consumption in microeconomics

In
microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focu ...
,
consumer choice The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
is a theory that assumes that people are rational consumers. And they decide on what combinations of goods to buy based on their utility function (which goods provide them with more use/happiness) and their budget constraint (which combinations of goods they can afford to buy). Consumers try to maximize
utility As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosophe ...
while staying within the limits of their budget constrain. Or to minimalize cost while getting the target level of utility. A special case of this is the consumption-leisure model where a consumer chooses between a combination of leisure and working time, which is represented by income. But based on
behavioural economics Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...
consumers do not behave rationally and they are influenced by other factors than their utility from the given good. Those factors can be the popularity of given good or its position in a supermarket.


Consumption in macroeconomics

In
macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, an ...
in the theory of
national accounts National accounts or national account systems (NAS) are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry ...
consumption is not only the amount of money that is spent by households on goods and services from companies. But also the expenditures of government that are meant to provide things for citizens they would have to buy themselves otherwise. This means things like healthcare. Where consumption is equal to income minus savings. Consumption can be calculated via this formula: C=C_0+c*Y_d Where C_0 stands for autonomous consumption which is minimal consumption of household that is achieved always, by either reducing the savings of household or by borrowing money. c is marginal propensity to consume where c \in ,1/math> and it reveals how much of household income is spent on consumption. Y_d is the disposable income of the household.


Consumption as a measurement of growth

Consumption of
electric energy Electrical energy is energy related to forces on electrically charged particles and the movement of electrically charged particles (often electrons in wires, but not always). This energy is supplied by the combination of electric current and electr ...
is positively correlated with economical growth. As electric energy is one of the most important inputs of the economy. Electric energy is needed to produce goods and to provide services to consumers. There is a statistically significant effect of electrical energy consumption and economic growth that is positive. Electricity consumption reflects economic growth. With the gradual rise of people's material level, electric energy consumption is also gradually increasing. In Iran, for example, electricity consumption has increased along with economic growth since 1970. But as countries continue to develop this effect is decreasing as they optimize their production, by getting more energy-efficient equipment. Or by transferring parts of their production to foreign nations where the cost of electrical energy is smaller.


Determinant factors of consumption

The main factors affecting consumption studied by economists include: Income: Economists consider the income level to be the most crucial factor affecting consumption. Therefore, the offered consumption functions often emphasize this variable. Keynes considers absolute income, Dosnbery considers relative income, and Friedman considers permanent income as factors that determine one's consumption. Consumer expectations: Changes in the prices would change the real income and purchasing power of the consumer. If the consumer's expectations about future prices change, it can change his consumption decisions in the present period. Consumer assets and wealth: These refer to assets in the form of cash, bank deposits, securities, as well as physical assets such as stocks of durable goods or real estate such as houses, land, etc. These factors can affect consumption; if the mentioned assets are sufficiently liquid, they will remain in reserve and can be used in emergencies. Consumer credits: The increase in the consumer's credit and his credit transactions can allow the consumer to use his future income at present. As a result, it can lead to more consumption expenditure compared to the case that the only purchasing power is current income. Interest rate: Fluctuations in interest rates can affect household consumption decisions. An increase in interest rates increases people's savings and, as a result, reduces their consumption expenditures. Household size: Households' absolute consumption costs increase as the number of family members increases. Although for some goods, as the number of households increases, the consumption of such goods would increase relatively less than the number of households. This happens due to the phenomena of the economy of scale. Social groups: Household consumption varies in different social groups. For example, the consumption pattern of employers is different from the consumption pattern of workers. The smaller the gap between groups in a society, the more homogeneous consumption pattern within the society. Consumer taste: One of the important factors in shaping the consumption pattern is consumer taste. This factor, to some extent, can affect other factors such as income and price levels. On the other hand, society's culture has a significant impact on shaping the tastes of consumers. Area: Consumption patterns are different in different geographical regions. For example, this pattern differs from urban and rural areas, crowded and sparsely populated areas, economically active and inactive areas, etc.


Consumption theories

Consumption theories began with John Maynard Keynes in 1936 and were developed by economists such as Friedman, Dusenbery, and Modigliani. The relationship between consumption and income was a crucial concept in macroeconomic analysis for a long time.


Absolute Income Hypothesis

In his 1936 General Theory, Keynes introduced the consumption function. He believed that various factors influence consumption decisions; But in the short run, the most important factor is real income. According to the Absolute Income Hypothesis, consumer spending on consumption goods and services is a linear function of his current disposable income.


Relative Income Hypothesis

James Dusenbery proposed this model in 1949. This theory is based on two assumptions: 1- People's consumption behavior is not independent of each other. In other words, two people with the same income that live in two different positions within the income distribution will have different consumptions. In fact, one compares oneself with other people, and what has a significant impact on one's consumption is one's position among individuals and groups in society; Therefore, a person only feels an improvement in his situation in terms of consumption if his average consumption increases relative to the average level of society. This phenomenon is called the Demonstration Effect. 2- Consumer behavior over time is irreversible. This means that when income declines, consumer spending is sticky to the former level. After getting used to a level of consumption, a person shows resistance to reducing it and is unwilling to reduce that level of consumption. This phenomenon is called the ratchet effect.


Intertemporal consumption

The model of
intertemporal consumption Economic theories of intertemporal consumption seek to explain people's preferences in relation to consumption and saving over the course of their lives. The earliest work on the subject was by Irving Fisher and Roy Harrod, who described 'hump sa ...
was first thought of by John Rae in
1830s The 1830s (pronounced "eighteen-thirties") was a decade of the Gregorian calendar that began on January 1, 1830, and ended on December 31, 1839. In this decade, the world saw a rapid rise of imperialism and colonialism, particularly in Asia and ...
and it was later expanded by
Irving Fisher Irving Fisher (February 27, 1867 – April 29, 1947) was an American economist, statistician, inventor, eugenicist and progressive social campaigner. He was one of the earliest American neoclassical economists, though his later work on debt defl ...
in
1930s File:1930s decade montage.png, From left, clockwise: Dorothea Lange's photo of the homeless Florence Thompson shows the effects of the Great Depression; due to extreme drought conditions, farms across the south-central United States become dry and ...
in the book ''Theory of interest''. This model describes how consumption is distributed over periods of life. In the basic model with 2 periods for example young and old age. S_1=Y_1 - C_1 And then C_2 = Y_2 + S_1 \times (1+r) Where C is the consumption in a given year. Where Y is the income received in a given year. Where S are saving from a given year. Where r is the interest rate. Indexes 1,2 stand for period 1 and period 2. This model can be expanded to represent each year of a lifetime.


Permanent income hypothesis

Is an economical theory developed by Milton Friedman in
1950s The 1950s (pronounced nineteen-fifties; commonly abbreviated as the "Fifties" or the " '50s") (among other variants) was a decade that began on January 1, 1950, and ended on December 31, 1959. Throughout the decade, the world continued its re ...
in his book ''A theory of Consumption Function''. This theory divides income into two components Y_t is transitory income and Y_pis permanent income. WhereY = Y_t + Y_p holds. Based on changes of income consumption changes as well, but in this theory, it meters which component of income changes. If Y_p changes then consumption changes accordingly by \alpha \times Y_p. Where \alpha is marginal propensity to consume. (If we expect part of income to be saved or invested otherwise \alpha = 1 ). On the other hand, if Y_t changes (for example winning lottery). Then this increase in income is distributed over the remaining life span. For example, winning $1000 with the expectation of living for 10 more years. Will result in yearly increase of consumption by $100


Life-cycle hypothesis

The
life-cycle hypothesis In economics, the life-cycle hypothesis (LCH) is a model that strives to explain the consumption patterns of individuals. Background The hypothesis Implications Saving and wealth when income and population are stable The effect of populatio ...
was published by
Franco Modigliani Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at University of Illinois at Urbana–Champaign, Carnegie Mellon Univ ...
in 1966. It describes how people make consumption decisions based on their current and future and past income, as they tend to distribute their consumption over their lifetime. It is, in its basic form: C=1/T \times W + 1/T \times (R\times Y) Where C is the consumption in given year. Where T is the number of years the individual is going to live for. Where R is for how many more years will the individual be working. Where Y is the average wage the individual will be paid over his or her remaining work time And W is the wealth he has already accumulated in his or her life.


Old-age spending

''Spending the Kids' Inheritance'' (originally the title of a book on the subject by
Annie Hulley Annie Hulley (born 23 October 1955 in Wakefield, West Riding of Yorkshire) is an English television and stage actress who has appeared in the British soap-operas ''Emmerdale ''Emmerdale'' (known as ''Emmerdale Farm'' until 1989) is a Bri ...
) and the acronyms SKI and SKI'ing refer to the growing number of older people in
Western society Leonardo da Vinci's ''Vitruvian Man''. Based on the correlations of ideal Body proportions">human proportions with geometry described by the ancient Roman architect Vitruvius in Book III of his treatise ''De architectura''. image:Plato Pio-Cle ...
spending their money on travel, cars and
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...
, in contrast to previous
generation A generation refers to all of the people born and living at about the same time, regarded collectively. It can also be described as, "the average period, generally considered to be about 20–⁠30 years, during which children are born and g ...
s who tended to leave that money to their children. ''According to a study from 2017 that was conducted in the USA 20% of married people consider leaving inheritance a priority, while 34% do not consider it as a priority. And about one in ten unmarried Americans (14 percent) plan to spend their retirement money to improve their lives, rather than saving it to leave an inheritance to their children. In addition, three in ten married Americans (28 percent) have downsized or plan to downsize their home after retirement.''https://s1.q4cdn.com/959385532/files/doc_downloads/research/2018/Marriage-and-Money-Survey.pdf ''Die Broke'' (from the book ''Die Broke: A Radical Four-Part Financial Plan'' by Stephen Pollan and
Mark Levine Mark Andrew LeVine is an American historian, musician, writer, and professor. He is a professor of history at the University of California, Irvine. Education LeVine received his B.A. in comparative religion and biblical studies from Hunter ...
) is a similar idea.


See also

*
Aggregate demand In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is ...
*
Consumer debt In economics, consumer debt is the amount owed by consumers (as opposed to amounts owed by businesses or governments). It includes debts incurred on purchase of goods that are consumable and/or do not appreciate. In macroeconomic terms, it i ...
*
Classification of Individual Consumption by Purpose Classification of Individual Consumption According to Purpose (COICOP) is a Reference Classification published by the United Nations Statistics Division that divides the purpose of individual consumption expenditures incurred by three institutional ...
(COICOP) *
Consumer choice The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
* Consumerism *
Life cycle hypothesis In economics, the life-cycle hypothesis (LCH) is a model that strives to explain the consumption patterns of individuals. Background The hypothesis Implications Saving and wealth when income and population are stable The effect of populatio ...
*
Measures of national income and output A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), gross national product (GNP), net national income (NNI), and adjusted na ...
*
Overconsumption Overconsumption describes a situation where a consumer overuses their available goods and services to where they can't, or don't want to, replenish or reuse them. In microeconomics, this may be described as the point where the marginal cost of ...
*
Permanent income hypothesis The permanent income hypothesis (PIH) is a model in the field of economics to explain the formation of consumption patterns. It suggests consumption patterns are formed from future expectations and consumption smoothing. The theory was develope ...
*
List of largest consumer markets Below is a list of the largest consumer markets of the world, according to data from the World Bank. The countries are sorted by their Household final consumption expenditure (HFCE) which represents consumer spending in nominal terms. If measured ...


References


Further reading

* * * * * * * * * *


External links


An essay examining the strengths and weaknesses of Keynes's theory of consumption
{{Authority control Consumption Macroeconomic aggregates