Consumption

Consumptionisdescribedasthefinalpurchaseofgoodsand
servicesbyindividuals.
Itisalsooftenreferredtoasconsumerspending
Businessesdependuponconsumption
Everytimeoneuseitsdebitandcreditcard
Ithelpstodeterminethegrowthand
successoftheeconomy
LargestcomponentsofGDP

by 2025, India will be the fifth largest consumer market after the US,
Japan, China and Britain.

Determinant of consumption
Disposable income: The relationship between consumption and
disposableincomeisalmostproportional.
Short-termchangesinconsumptionandincomearenotveryhighly
correlated because of expected income (permanent income). In the
long run, the relationship between consumption and disposable
incomeisalmostproportional.
Expected disposable income: Changes in the expectations of the
people also influence the propensity to consume. When people
expect that war will break out in the near future and they expect
pricestogoup,thentheywilltrytospendmoreongoodssoasto
meettheneedsoftheimmediatefuture.
Newcollegegraduatesoftenspendmorethantheircurrentincome

Apartfromincometherearemanyothersubjectiveand
objectivefactorswhichcaninfluenceconsumption.
Change in tax (Direct and Indirect)
Demographic factor and distribution
Family size
spendingonDurablegoodornon-durablegood
Social Security
Un-employmentrelief,medicalfacilities,oldagepensionsetc

Credit availability
Spendingondurablegoodincreases/(Interestrateandinflation)
Expected rate of return
Advertisement
Attitude towards saving
Shock /climate change

Consumption theories
Absolute income hypothesis (Keynes)
Non-proportionalrelationbetweenconsumption
ConceptofAPCandMPC
Howevershort-runnonproportionalbutinlongrunitis
proportional
Keynesfocusesmoreonshort-run

Permanent income hypothesis (Friedman/1957)

Freidmanrejectstheuseofcurrentincomeasthedeterminantof
theconsumptionexpenditure
CurrentIncome=PermanentIncomeandTransitoryIncome
The permanent income hypothesis (PIH) states that the amount
consumersspendisproportionaltotheirpermanentincome(long
termexpectedIncome)

People experience random and temporary changes in their

income/consumption
Familysize,Socialsecurity,savingsandtypeofsavings
But in a developing and highly populated country, where
numberofpooraremoreitisdifficult

Relative income hypothesis (Duesenbery)

AnAmericaneconomistJ.S.Duesenberryputforwardthetheoryof
consumer behavior which lays stress on relative income of an
individual rather than his absolute income as a determinant of his
consumption.
Individualconsumptionisnotindependentbutinterdependentofthe
behaviorofother
Consumption of an individual is not the function of his absolute
income but of his relative position in the income distribution in a
society.
Forexample,iftheincomesofallindividualsinasocietyincreaseby
the same percentage, then his relative income would remain the
same,thoughhisabsoluteincomewouldhaveincreased.

Average propensity to consume (APC) will remain the same

despitetheincreaseinhisabsoluteincome.
Middle-classvs.Richclass,Inequality,Wealth
Consumption relations are irreversible and not reversible in
time(Ratcheteffect/demonstrationeffect)

Demonstration Effect:
Byemphasizingrelativeincomeasadeterminantofconsumption,
the relative income hypothesis suggests that individuals or
households try to imitate or copy theconsumption levels of their
neighbors or other families in a particular community. This is
calleddemonstrationeffect.
Ratchet Effect:
whenincomeofindividualsorhouseholdsfalls,theirconsumption
expenditure does not fall much. This is often called a ratchet
effect.Thisisbecause,accordingtoDuesenberry,thepeopletryto
maintain their consumption at the highest level attained earlier.
This is partly due to the demonstration effect explained above.
Peopledonotwanttoshowtotheirneighborsthattheynolonger
affordtomaintaintheirhighstandardofliving.

Life cycle hypothesis (Ando and Modigilani)

life cycle hypothesis (LCH) states that people distribute their
consumption over their life cycle (lifetime expected income,
resourceavailability,returnoncapital,spendingplanandtheage
atwhichtheplanismade)inordertomaximizeutilityduringtheir
lifetime.
That means dis-saving when they are just starting out, saving
duringpeakearningyears,andthendis-savingagainduringtheir
retirementyears.
It is assumed that the more wealth people have accumulated
during their working years, the more they will be able to spend
duringtheperiodofretirement

InvertedU(Kuznetcurve)

Angus Deaton, work on consumption

Angus Deaton, born in Scotland but a longtime professor at
Princeton,haswonthe2015NobelPrizeforEconomics"forhis
analysisofconsumption,poverty,andwelfare."
Howdoconsumersdistributetheirconsumptionamongdifferent
goodsinaspecifictimeperiodgiventheirtotalexpendituresin
thatperiod?
Forecastingactualconsumptionpatternsiscrucialinevaluating
how policy reforms, like changes in consumption taxes, affect
thewelfareofdifferentgroups.

How much of society's income is spent and how much is saved?

(Paradox of thrift)
Deaton showed that the prevailing consumption theory could not
explaintheactualrelationshipsifthestartingpointwasaggregate
incomeandconsumption.
Instead, one should sum up how individuals adapt their own
consumptiontotheirindividualincome,whichfluctuatesinavery
differentwaytoaggregateincome.Like:somepeopleprefertogo
forinsurance
This research clearlydemonstratedwhytheanalysisof individual
dataiskeytountanglingthepatternsweseeinaggregatedata,an
approach that has since become widely adopted in modern
macroeconomics.

Howdowebestmeasureandanalyzewelfare(Inequality)and
poverty?
Inhismorerecentresearch,Deatonhighlightshowreliable
measuresofindividualhouseholdconsumptionlevelscanbe
usedtodiscernmechanismsbehindeconomicdevelopment.
Hisresearchhasuncoveredimportantpitfallswhencomparing
theextentofpovertyacrosstimeandplace.

It has also exemplified how the clever use of household data

may shed light on such issues as the relationships between
income and calorie intake, and the extent of gender
discriminationwithinthefamily.
Deaton's focus on household surveys has helped transform
development economics from a theoretical field based on
aggregatedatatoanempiricalfieldbasedondetailedindividual
data.
TheconnectionbetweenlackofgrowthamongIndianchildren
due to very low calorie consumption and its connection with
povertyinthecountry.