Consumption is the act of using resources to satisfy current needs and wants. It is seen in contrast to
investing
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing i ...
, which is spending for acquisition of ''future'' income. Consumption is a major concept in
economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
and is also studied in many other
social sciences
Social science is one of the branches of science, devoted to the study of societies and the relationships among individuals within those societies. The term was formerly used to refer to the field of sociology, the original "science of so ...
.
Different schools of economists define consumption differently. According to
mainstream economists, only the final purchase of newly produced
goods
In economics, goods are items that satisfy human wants
and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not ...
and
services by individuals for immediate use constitutes consumption, while other types of expenditure — in particular,
fixed investment
Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time.
Thus, fixed investment is the accumulation of physical assets such as machinery, lan ...
,
intermediate consumption, and government spending — are placed in separate categories (see
consumer choice
The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pre ...
). Other economists define consumption much more broadly, as the aggregate of all economic activity that does not entail the design, production and
marketing
Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to emph ...
of
goods and services (e.g. the selection, adoption, use, disposal and recycling of goods and services).
Economists are particularly interested in the relationship between consumption and income, as modelled with the
consumption function. A similar realist structural view can be found in consumption theory, which views the Fisherian intertemporal choice framework as the real structure of the consumption function. Unlike the passive strategy of structure embodied in inductive structural realism, economists define structure in terms of its invariance under intervention.
Behavioural economics, Keynesian consumption function
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 led to the development of
Milton Friedman
Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...
's
permanent income hypothesis and
Franco Modigliani
Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at University of Illinois at Urbana–Champaign, Carnegie Mellon Un ...
's
life cycle hypothesis.
More recent theoretical approaches are based on
behavioural economics and suggest that a number of behavioural principles can be taken as microeconomic foundations for a behaviourally-based aggregate consumption function.
Behavioural economics also adopts and explains several human behavioural traits within the constraint of the standard economic model. These can range from: bounded rationality bounded willpower, and bounded selfishness.
Bounded rationality was first proposed by Herbert Simon. This means that people sometimes respond rationally to their own cognitive limits, which aimed to minimize the sum of the costs of decision making and the costs of error. In addition, Bounded willpower refers to the fact that people often take actions that they know are in conflict with their long-term interests. For example, most smokers would rather not smoke, and many smokers willing to pay for a drug or a program to help them quit. Finally, bounded self-interest refers to an essential fact about the utility function of a large part of people: under certain circumstances, they care about others or act as if they care about others, even strangers.
Consumption and household production
Aggregate consumption is a component of
aggregate demand.
Consumption is defined in part by comparison to
production.
In the tradition of the Columbia School of Household
Economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
, also known as the
New Home Economics, commercial consumption has to be analyzed in the context of household production. The 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
In economics, goods are items that satisfy human wants
and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not ...
and
services by individuals constitutes consumption, while other types of expenditure — in particular,
fixed investment
Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time.
Thus, fixed investment is the accumulation of physical assets such as machinery, lan ...
,
intermediate consumption, and government spending — are placed in separate categories (See
consumer choice
The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pre ...
). Other economists define consumption much more broadly, as the aggregate of all economic activity that does not entail the design, production and
marketing
Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to emph ...
of
goods and services (e.g. the selection, adoption, use, disposal and recycling of goods and services).
Consumption can also be measured in a variety of different ways such as
energy
In physics, energy (from Ancient Greek: ἐνέργεια, ''enérgeia'', “activity”) is the quantitative property that is transferred to a body or to a physical system, recognizable in the performance of work and in the form of ...
in
energy economics metrics.
Consumption as part of GDP
GDP (Gross domestic product) is defined via this formula:
Where
stands for consumption.
Where
stands for total government spending. (including salaries)
Where
stands for Investments.
Where
stands for net exports. Net exports are exports minus imports.
In most countries consumption is the most important part of GDP it ranges usually ranges from 45% from GDP to 85% of GDP.
Consumption in microeconomics
In
microeconomics
Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...
,
consumer choice
The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pre ...
is a theory that assumes that people are rational consumers. And they decide on what combinations of goods to buy based on their utility function (which goods provide them with more use/happiness) and their budget constraint (which combinations of goods they can afford to buy). Consumers try to maximize
utility
As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosophe ...
while staying within the limits of their budget constrain. Or to minimalize cost while getting the target level of utility. A special case of this is the consumption-leisure model where a consumer chooses between a combination of leisure and working time, which is represented by income.
But based on
behavioural economics consumers do not behave rationally and they are influenced by other factors than their utility from the given good. Those factors can be the popularity of given good or its position in a supermarket.
Consumption in macroeconomics
In
macroeconomics in the theory of
national accounts consumption is not only the amount of money that is spent by households on goods and services from companies. But also the expenditures of government that are meant to provide things for citizens they would have to buy themselves otherwise. This means things like healthcare. Where consumption is equal to income minus savings. Consumption can be calculated via this formula:
Where
stands for autonomous consumption which is minimal consumption of household that is achieved always, by either reducing the savings of household or by borrowing money.
is marginal propensity to consume where