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.
Consumption in Neoclassical Economics
Neoclassical economists view consumption as the final purpose of an economic activity, hence, the per person value is an important factor in determining the productive success in an economy.
Macroeconomists use this economic measure for two reasons. The first is to assess aggregate savings in each household; savings refer to the portion of income that is not used for consuming goods and services. Aggregate savings in the economy feeds into the national supply of capital. Therefore, it can be used to assess the long-term productive capacity of an economy.
Secondly, consumption behavior provides a good measure of the total national output in the economy. The total output can be used to understand the reasons for macroeconomic fluctuations in the business cycle.
The behavior data can be used to measure poverty, understand the retirement rate in households, and test theories of competition in the economy. Data from households allows macroeconomists to understand spending behavior, and the figures can be used to examine relationships between consumption and factors such as unemployment and education costs.
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.