What is consumer spending? With definition and importance

By Indeed Editorial Team

Published 14 November 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Economics is a discipline making use of a selection of different metrics, with economists collating data as a means of understanding the wider state of the economy. This includes understanding the way people spend their money in an economy and the reasons behind their spending. As an economist, you benefit from knowing all about consumer spending and converting this metric into a greater level of insight. In this article, we discuss what consumer spending is, review the importance of customer spending in an economy and explore some of the factors that affect customer spending throughout a modern economy.

What is consumer spending?

Consumer spending, or Personal Consumption Expenditures (PCEs), refers to the value of all of the goods and services people purchase within an economy. This specifically refers to consumer products, with the end user's spending being an important measure of the performance of the wider economy. This is the final stage of economic activity, and as a result, is a strong indicator of an economy's general health.

Depending on the economist, different theories place different levels of importance on PCEs. Supply-side economics prefer a focus on savings and production levels as a means of measuring the health of the economy. PCEs can be an indicator of economic health, as high PCEs are indicative of consumers having a high level of confidence in the economy and spending a lot, which companies then spend on further investments and products. High spending by consumers is a sign of an active economy with a high level of confidence throughout.

Related: What are economic factors? (Importance and examples)

What do personal consumption expenditures entail?

There are several different aspects to customer spending, including:

Induced consumption

Induced consumption is the part of PCE that varies in line with somebody's disposable income. Put simply, as someone's disposable income increases, the amount they spend on induced consumption increases. This specifically refers to items such as luxury goods and services. For induced consumption, consumption levels are at zero when disposable income is at zero, as people have no money to spend on luxury goods after dealing with the necessities.

The rate of change of induced consumption is not necessarily one-to-one. For example, in a weak economy, some people prefer to save. This means that as disposable income increases by £100, people only spend £25 on induced consumption. In more confident economies this sum is higher, as people see less of a requirement to save money for the future. The marginal rate of induced spending changes in line with confidence, as an increase in disposable income always causes an increase in induced spending.

Related: VAT vs sales tax: definition, similarities and differences

Autonomous spending

Autonomous spending is the proportion of expenditure that takes place even when disposable income levels are at zero. This consumption includes the necessities consumers pay for in all circumstances. This includes rent payments, energy bills and transportation spending. Paying taxes and tolls is not a part of autonomous spending, as this is money that goes to authorities rather than companies in exchange for a good or service. Regardless of the income someone has, they pay for this section of expenditure.

The rate of autonomous spending is relatively constant. This is because the rate of income in an economy does not affect the autonomous spending level. One of the factors changing the level of autonomous spending is inflation, as a significant increase in the cost of housing, energy or fuel leads to increasing prices for necessities across the economy. In many cases, consumers have no control over the amount they spend on autonomous costs, with very few exceptions such as the cost of housing in a specific area.

Related: 8 demand examples and how they may affect a company's sales

Why is consumer spending important?

Customer spending is important for several reasons, including:

Indicating demand

The level of customer spending in an economy demonstrates the level of demand in the economy. This is an ideal tool for economists to see the upward trajectory of the economy. As the economy relies on demand levels, economists examine PCE levels for a better idea of whether there's a period of growth or recession. Economists and politicians use this data when preparing budgets and understanding whether the ideal direction of government policy is to drive demand or limit consumer expenditures.

Related: Aggregate demand: definition and how to calculate it

Targeting specific policies

Governments and economists use PCE data from a selection of different sectors as a means of guiding policies. For example, if the economy is strong except for consumer expenditures in the renewable energy sector, the government can consider using subsidies as a means of encouraging citizens to buy solar panels from providers. Alternatively, a demerit good that increases spending, such as fast food, means that policies such as increasing tax rates on those products are ideal policies. Understanding how consumers spend is a powerful insight government officials have available to them.

Related: What are fiscal policies? (Plus how they work and types)

Planning product releases

Companies with access to spending information use it to their benefit by planning the timing of product releases. A company releasing a product when aggregate demand is high ensure that the product has a better chance of succeeding in the market, as people have more money to spend on products. By understanding where the economy is in its cycle and what this means for a product, business owners ensure their products release at the right times and maximise their revenue as a result of timing their releases better.

Related: A complete guide to preparing for a product launch

Budget planning

Individual companies use PCE data as a method of controlling their budgets for several years to come. When spending is high, companies benefit from saving some of their excess profits for more difficult times. A business seeing that the level of consumer demand is currently low but soon to increase recommends more investment, so products release exactly when demand peaks. Having more information, especially on a macroeconomic scale, is a necessity for any company to maximise its profits.

Related: How to manage a budget: techniques and a step-by-step guide

What factors affect consumer spending?

Several different factors affect aggregate PCE levels, including:

Interest rates

Interest rates have a significant influence on the way people spend in an economy. For example, when interest rates are high people spend significantly less on a day-to-day basis, as putting their money in savings accounts yields significantly higher rewards than when interest rates are low. High-interest rates also reduce disposable income by increasing the cost of mortgages and loans over time.

Related: How to calculate APR (with formulas, types and examples)

Availability of credit

The availability of credit in an economy dictates whether people have enough confidence for buying more products. Following the economic crisis, lenders were less likely to provide credit to people. Consumption falls as people have less funding available to continue their lifestyles. The more credit people have available, the more they spend as they have a greater theoretical disposable income.

Related: How to become a credit risk analyst (with duties and skills)

Cost of living

The wider cost of living influences the amount people spend. As inflation rates on necessities such as energy increase, people spend less money on less necessary items such as luxury goods. Where the volume of spending in the economy is the same, the number of items circulating is lower thanks to the higher cost of simple goods and services. Induced consumption shrinks as an increase in autonomous consumption puts a greater level of pressure on disposable incomes.

Related: What is net cost? (With definition, formula and tips)

Culture

An area's culture influences the way consumption occurs. In areas with a history of deprivation, people with higher disposable incomes still spend less. This is because they developed a habit of saving money throughout their lives, which is a significant part of the culture of a deprived area. Falling disposable incomes in a wealthy area have less of an impact on consumption, as people tend to retain the lifestyles they had previously.

Tax rates

One of the tools governments use for affecting the rate of spending in an economy is tax rates. If consumption is low throughout an economy, or even within specific tax brackets, governments reduce taxes as a means of providing more disposable income for their citizens. The reverse also happens, as governments use higher tax rates as a means of lowering demand in an economy and reducing inflationary pressures such as high aggregate demand.

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