What is Consumption?

Consumption is defined as the use of goods and services by a household. It is a component in the calculation of the Gross
Domestic Product (GDP). Macroeconomists typically use consumption as a proxy of the overall economy.

When valuing a business, a financial analyst would look at the consumption trends in the business’ industry. It is an important
step, as it helps the analyst with the assumption section of the financial model. Importance of Consumption

Modern economists give a lot of importance to the level of consumption in the economy because it characterizes the economic
system the country currently operates in.

1. The beginning of all economic activity

Consumption is the start of all human economic activity. If a person desires something, he will take action to satisfy this desire.
The result of such an effort is consumption, which also means the satisfaction of human wants.

2. End of economic activities

If, for example, a person desires a sandwich, they will take the effort to make the sandwich. Once it is made, the food is
consumed, resulting in the end of an economic activity.

3. Consumption drives production

According to economist Adam Smith, “Consumption is the sole purpose of all production.” It means that the production of
goods and services is dependent on the level of consumption.

4. Economic theories

The study of consumption theory has helped economists formulate numerous theories such as the Law of Demand, the
Consumer Surplus concept, and the Law of Diminishing Marginal Utility. These theories help analysts understand how individual
behavior affects the input and output in the economy.

5. Government theories

Consumption habits also help the government formulate theories. The minimum wage rate and tax rate are determined based
on the habits of individuals. It also helps the government make decisions on the production of essential and non-essential
commodities in a country. It also provides the government with insight into the saving to spending ratio in the economy.

6. Income and employment theory

Consumption plays an important role in the income and employment theory under Keynesian economics as put forth by John
Maynard Keynes. Keynesian theory states that if consuming goods and services does not increase the demand for such goods
and services, it leads to a fall in production. A decrease in production means businesses will lay off workers, resulting in
unemployment. Consumption thus helps determine the income and output in an economy.

Consumption Cycle
 Consumption and the Business Cycle

Consumption expenditure in the private sector accounts for two-thirds of the Gross Domestic Product (GDP). The
remaining one-third consists of government expenditure and net exports. Private consumption is divided into three
categories: Durable goods that are defined as goods with a lifetime greater than three years, services that include
travel and car repairs, and non-durable goods such as food and water that can be immediately consumed.

The consumption flow and expenditure (consumption expenditure) can help analysts understand the fluctuations in
the business cycle. Producers of durable goods only earn income from the sale of the initial product (expenditure),
not from consuming the goods following the purchase.

Hence, it is expenditure and not consumption flow that determines short-term economic prosperity. Due to the
nature of durable goods, economists have created a rational optimization framework to account for the goods.
During an economic downturn, consuming durable goods decreases because the goods require a significant
investment, and consumers will put off the purchases until economic conditions improve.

When the economy recovers, spending on durable goods increases and becomes more volatile than spending
on non-durable goods. A change in interest rates, tax rates, or other stimulus measures affects spending on
durables more than any other kind of spending. USA - Consumption

Second estimate confirms GDP contracts at historic rate in Q2

The economy declined at the sharpest rate on record in the second quarter as the pandemic and measures to contain it toppled activity. According to a second
estimate GDP estimate released by the Bureau of Economic Analysis, the economy contracted 31.7% in Q2 in seasonally-adjusted annualized terms (SAAR),
after shrinking 5.0% in the previous quarter. In annual terms, GDP plunged a titanic 9.1% in Q2, contrasting the first quarter’s 0.3% growth.

The main headwind in Q2 came from private consumption, which plunged 34.1% SAAR (Q1: -6.9% SAAR). Moreover, the downturn in business investment
intensified significantly (Q2: -26.0% SAAR; Q1: -6.7% SAAR) on a marked drop in equipment investment. That said, government consumption growth accelerated
in the quarter (Q2: +2.8% SAAR; Q1: +1.3% SAAR).

Turning to the external sector, exports of goods and services dived 63.2% in the second quarter (Q1: -9.5% SAAR), led by a freefall in exports of goods, while
imports of goods and services shrank 54.0% (Q1: -15.0% SAAR). The external sector thus contributed 0.9 percentage points to the headline figure (Q1: +1.1
percentage points).

Commenting on the second quarter’s performance, James Marple, a senior economist at TD Economics, noted:

“We've had some time to digest the unprecedented decline in economic activity that took place earlier this year. Attention is now on the pace of the comeback.
While there are signs of slowing in activity through the summer months as the virus spread, the switching on of the economy in May and June will still show up in
double-digit annualized growth (likely in the neighborhood of 25% to 30% annualized) in the third quarter.” 
Focus Economics Consensus Forecast panelists see GDP contracting 5.3% in 2020, which is up 0.2 percentage points from last month’s estimate, before growing
4.0% in 2021.

United States - Consumption Data

2015   2016   2017   2018   2019  

Consumption (annual 3.7   2.7   2.6   3.0   2.6  

variation in %)