Factors that Affect Consumption Expenditure

Factors that Affect Consumption Expenditure

There are numerous factors that affect consumption expenditure thereby affecting the economy. Consumption expenditure refers to the expenses that are incurred for consumption purposes instead of the expenses that are incurred for production purposes. It comprises of the expenses that households incur when buying final goods or services. This expenditure plays an important role in the macroeconomic activity that affects the long-run economic growth and short-run business cycles. The general consumption process is the key motivation of consumption expenditures. This refers to the use of services and goods to satisfy needs. Consumption expenditure entails the purchase of different services and goods. It is divided into durable goods which are the tangible goods, nondurable goods which are goods that last for over a year and services which are intangible.

Factors that affect consumption expenditure and how they do it

At the macro-economic level, the consumption expenditure is reliable and steady. 90 percent of the disposable income of the consumer or household sector is regularly devoted to consumption expenditure. However, several factors cause a change in the amount of consumption expenditure in different ways.

They include:

Disposable income is the main determinant of the aggregate levels of consumption in a community. With other things equal, households tend to spend on consumption more when income levels are higher. Disposable income is determined by factors like wages, living costs and taxes. For instance, a VAT cut will increase the level of disposable income while encouraging spending. An increase in living costs without matching wages will reduce consumer expenditure.

  • Credit cost

Consumption patterns are influenced by interest rates. This is because credit is used by most consumers in funding consumer durables purchases. When interest rates are low, the aggregate consumption expenditure is affected positively. This is because it causes a decrease in the interest payments for the borrowed money thereby taking a smaller amount of the disposable income. Additionally, there is a decrease in the opportunity cost of the expenditure on the consumer items.

When households have surplus funds, they can save or spend it. When the interest rates fall, saving becomes less attractive due to low return. When interest rates rise, consumption decisions might be postponed. A larger disposable income proportion goes to the repayment of the borrowed funds and there is a rise in the opportunity cost for consumption. Households can forego higher returns that may result from lending surplus funds to the financial institutions.

  • Physical wealth

This refers to tangible, material possessions that a household has especially the durable goods which include furniture, cars and kitchen appliances. Increased physical wealth decreases consumption expenditures. Consumers who recently bought durable goods are less likely to purchase more. This leads to a decrease in their consumption expenditure.

  • Financial wealth

This refers to bonds, money, stocks, mutual funds and bank accounts among others which have a claim to resources, goods, as well as productive assets. Consumers with increased financial wealth have a tendency to spend in a more freely manner. This increases consumption expenditure.

  • Confidence about the future

If consumers are less confident about the future, such as when they have the fear of being unemployed, they are likely to spend less and save more. Inflationary expectations also affect consumption expenditures. When consumers suspect that there will be an increase in prices due to inflation, they are likely to spend more now on purchases leading to an increase in consumption expenditure.

  • Government policies

Aggregate consumption is affected by government policies. This is because disposable income is affected by the fiscal policy through taxation. Interest rates are affected by monetary policy thereby affecting credit cost.

When are factors that affect consumption expenditure important?

Consumption expenditure data is very important for purposes of economic analysis. The government, through its economic agencies, uses this data to determine the components of consumer price index. With this data, the government determines the appropriate measures to take, such as introducing tax cuts and giving out more money to regulate consumption expenditure.

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