Consumption function[edit]

Main article: Consumption function

The consumption function is a mathematical function that expresses consumer spending in
terms of its determinants, such as income and accumulated wealth.

Behavioural economics and consumption[edit]

The Keynesian consumption function is also known as the absolute income hypothesis, 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 and Franco Modigliani's life cycle hypothesis. More recent theoretical
approaches are based on behavioral economics and suggest that a number of behavioural
principles can be taken as microeconomic foundations for a behaviourally-based aggregate
consumption function.[1]

Consumption and household production[edit]

Consumption is defined in part by comparison to production. In the tradition of the Columbia
School of Household Economics, also known as the New Home Economics, 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.[2][3] 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.[4]
Different schools of economists define production and consumption differently. According
to mainstream economists, only the final purchase of goods and services by individuals
constitutes consumption, while other types of expenditure — in particular, fixed
investment, intermediate consumption, and government spending — are placed in separate
categories (See consumer choice). Other economists define consumption much more
broadly, as the aggregate of all economic activity that does not entail the design, production
and marketing of goods and services (e.g. the selection, adoption, use, disposal and
recycling of goods and services).[citation needed]
Consumption can also be measured by a variety of different ways such as energy in energy
economics metrics.

Effects of consumption[edit]
Aggregate consumption is a component of aggregate demand.[5] According to the UN,
"today’s consumption is undermining the environmental resource base. It is
exacerbating inequalities. And the dynamics of the consumption-poverty-inequality-
environment nexus are accelerating. If the trends continue without change — not
redistributing from high-income to low-income consumers, not shifting from polluting to
cleaner goods and production technologies, not shifting priority from consumption for
conspicuous display to meeting basic needs — today’s problems of consumption and
human development will worsen." Developing countries like India, as they move down the
path of copying the consumption patterns of developed economies, will basically create
demands that earth will not be able to fulfill. Some economists[who?] talk about putting a price
on using earth's resources which is in addition to the cost of just extracting them.

An increase in the general level of prices implies a decrease in the purchasing

power of the currency. That is, when the general level of prices rises, each monetary
unit buys fewer goods and services.[18] The effect of inflation is not distributed
evenly, and as a consequence there are hidden costs to some and benefits to others
from this decrease in purchasing power. For example, with inflation lenders or
depositors who are paid a fixed rate of interest on loans or deposits will lose
purchasing power from their interest earnings, while their borrowers benefit.
Individuals or institutions with cash assets will experience a decline in the
purchasing power of their holdings. Increases in payments to workers and
pensioners often lag behind inflation, especially for those with fixed payments.[8]

High or unpredictable inflation rates are regarded as harmful to an overall economy.

They add inefficiencies in the market, and make it difficult for companies to budget
or plan long-term. Inflation can act as a drag on productivity as companies are
forced to shift resources away from products and services in order to focus on profit
and losses from currency inflation.[8] Uncertainty about the future purchasing power
of money discourages investment and saving.[19] And inflation can impose hidden
tax increases, as inflated earnings push taxpayers into higher income tax rates.

With high inflation, purchasing power is redistributed from those on fixed incomes
such as pensioners towards those with variable incomes whose earnings may better
keep pace with the inflation.[8] This redistribution of purchasing power will also occur
between international trading partners. Where fixed exchange rates are imposed,
rising inflation in one economy will cause its exports to become more expensive and
effect the balance of trade. There can also be negative impacts to trade from an
increased instability in currency exchange prices caused by unpredictable inflation.