Consumption (economics)

Consumption is a major concept in economics and is also studied by many other social sciences. Economists are particularly interested in the relationship between consumption and income, and therefore in economics the consumption function plays a major role.

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 &mdash; in particular, fixed investment, intermediate consumption, and government spending &mdash; 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).

Consumption function
It is a single mathematical function used to express consumer spending. It was developed by John Maynard Keynes and detailed most famously in his book The General Theory of Employment, Interest, and Money. The function is used to calculate the amount of total consumption in an economy. It is made up of autonomous consumption that is not influenced by current income and induced consumption that is influenced by the economy's income level. This function can be written in a variety of ways, an example being $$ C = a + b(Y-T)$$. This is probably the most simplistic form of the consumption function.

The simple consumption function is shown as the affine function:


 * $$C = c_0 + c_1 Y^d$$

where
 * C = total consumption,
 * c0 = autonomous consumption (c0 > 0),
 * c1 is the marginal propensity to consume (ie the induced consumption) (0 < c1 < 1), and
 * Yd = disposable income (income after government intervention – benefits, taxes and transfer payments – or Y + (G – T)).

Autonomous consumption represents consumption when income is zero. In estimation, this is usually assumed to be positive. The marginal propensity to consume (MPC), on the other hand measures the rate at which consumption is changing when income is changing. In a geometric fashion, the MPC is actually the slope of the consumption function.

The MPC is assumed to be positive. Thus, as income increases, consumption increases. However, Keynes mentioned that the increases (for income and consumption) are not equal. According to him, "as income increases, consumption increases but not by as much as the increase in income".

Behavioural Economics and Consumption
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 lead 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.

Consumption and Household Production
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. Opportunity cost of time affects the cost of home-produced substitutes and therefore demand for commercial goods and services.,. 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.

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 &mdash; in particular, fixed investment, intermediate consumption, and government spending &mdash; 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).

Consumption can also be measured by a variety of different ways such as energy in energy economics metrics.

Effects of consumption
Aggregate consumption can increase aggregate demand.

Old-age spending
Spending the Kids' Inheritance (originally the title of a book on the subject by Annie Hulley) and the acronyms SKI and SKI'ing refer to the growing number of older people in Western society spending their money on travel, cars and property, in contrast to previous generations who tended to leave that money to their children.

Die Broke (from the book Die Broke: A Radical Four-Part Financial Plan by Stephen Pollan and, Mark Levine) is a similar idea.

Journals

 * Review of Economics of the Household