If you spend your hard-earned cash on food, household supplies, video games, or services like water, plumbing, and the like - then you are what economists call a “consumer.” Consumer spending is one of the most critical parts of any economy, and that’s what we’re going to explore in this article.
We will first take a look at what exactly the term “consumer spending” means, then we’ll cover the major influencers of consumer spending. Finally, we’ll finish up by explaining how it all plays an important role in the success or failure of an economy.
Consumer Spending Explained
Consumer spending can be thought of as one cog in the wheel of an economy. The other important components are the production of goods and services and the distribution of said goods and services. However, consumer spending is what makes it all work because without us to spend money, companies and businesses wouldn’t produce nor have the need to distribute their products or services.
When looking at the way consumer spending breaks down, we mostly spend money on services such as utilities, healthcare, banking, rent/mortgage, insurance, and various other similar services. The rest of the money goes to what’s called durable and non-durable goods.
Think of durable goods as items that you buy very little because they last a long time. This includes things like cars, household appliances like washers and dryers, and other similar items you might purchase. Typically, if it lasts three years or longer, then it’s considered a “durable” good.
At the other end of the spectrum are nondurable goods. These are items that are used up fast or need to be replaced often, and we need to buy them over and over again. Some examples include food, gas, clothes, cigarettes, drinks like beer and soda, and anything similar to those.
If you’re familiar with the concept of supply and demand, then understand that consumer spending is the ultimate component of the “demand” side of things.
What are the Influencers of Consumer Spending?
There are five factors that influence the way people spend. These can be broken down into:
- Disposable Income
- Household Debt
- Income Inequality
- Per Income Capita
- Consumer Sentiment & Expectations
Let’s take a closer look at each of these in turn.
Disposable income is whatever money you have left over after accounting for taxes and any other financial obligations you may have. These other obligations tend to go towards things like health insurance or Social Security payments. While some of this cash could go into savings, it’s the most important influence of consumer spending because it’s the money we use to buy the things we want and need.
Whenever disposable income is high, people tend to be more lax with their spending: going to movies, paying for leisure items, and similar activities. However, when disposable income is low, people tend to draw back their spending and stick to spending strictly on needs. This relationship has one of the most profound effects on the economy.
Household debt is the total accumulated money owed by the people in your home. This could be in the form of credit card debt, student loan debt, medical debts, etc. It plays an important role in consumer spending because it directly affects how much disposable income the household has. As mentioned, when people don’t have as much extra money to go around, they tend to be more frugal in their spending and put less of their cash back into the economy. Today, overall consumer debt is at an all time high, with most of it coming from healthcare and student loan debt.
Racial, ethnic, and class disparities in the amount of money people make and have is called income inequality. When looking at how money is distributed, it’s best for the economy when most of it goes towards those making less because they are the ones more likely to use the cash for everyday needs such as food and paying bills. However, when the money goes to those in higher income brackets, they’re more likely to store and save their money which takes the money out of circulation, resulting in overall lower consumer spending.
Per Capita Income
Another fourth consumer spending determinant is per capita income. When looking at per capita income, it tells you how much money a nation has for each individual in the country. Now, per capita income doesn’t account for savings or investments, but it can be an indicator of the nation’s overall economic health.
Consumer Sentiment & Expectations
Consumer sentiment & expectations is our fifth and final determinant of consumer spending. Simply put, consumer sentiment measures how consumers feel about the state of the economy, their current financial situation, and the future of them both. A great example of how sentiment can dramatically affect consumer spending is when there's a national disaster such as the recent COVID-19 pandemic. When people are afraid, they’re spending behavior can drastically change where they either run out and panic buy or begin to hoard their money.
When it comes down to it, consumer spending is one of the most important factors when looking at the health of an economy. By looking at where people choose (or not) to spend can be a significant indicator in the direction the economy is moving towards.
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