With the endless demands that life has and the scarce resources consumers are endowed with, consumers are faced by challenges in making choices on what to spend and on what can wait for another time depending on the urgency of the need.
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Thus, it is important to note that consumers are always faced by trade-offs in their spending decisions due to the limitation of the income they earn and the numerous choices of needs they have to meet in order to derive maximum utility from their incomes.
To ensure that consumers make sound decisions on their spending, several factors are involved and they include; the budget constraint, government influence among others. Several economic concepts have thus been developed to try and explain how consumers make their spending decisions.
Among the well documented concepts is consumer sovereignty; this concept assumes that consumers are the best judges of their own welfare and that they make their personal decisions in order to further their self interests and desires. The concept further assumes that consumers behave rationally thus their choices enact their own interests.
Rationality involves the mental processes which one goes through before making an economic decision. For these economic decisions to be sound and working, they must align with the market conditions in order to avoid being misled by inappropriate choices which do not reflect the consumer’s true interests and preferences.
Rational choice theory seeks to explain human behavior as the outcome of an evaluative goal-driven system of cognitions. The question whether consumer rationality is always achieved when making economic decisions is a major concern to many economists as we will come to discover that not all consumers are rational.
Economists have often referred to consumer choice behavior as a sub-optimal decision making process due to the simple fact that consumers are over spenders because of their excessive desire for gratification through consumption. For example in the US, before the economic crisis in 2008, there was a major concern to policy makers that most of the Americans were spending more than they were earning and thus a disaster was roaming though no one knew when it could hit.
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Determinants of Consumer Spending
The Budget Constraint
Everybody would like to increase the quantity or quality of the goods and services they consume if such a chance was given to them. For example a consumer would love to own a Mercedes Benz if all he can afford as of now is a Toyota Vitz or eat in better restaurant than he is doing currently but as a matter of fact, most of the time consumers are forced to spend less than their hearts would desire because their spending is constrained by the income they earn (Mankiw, 1998).
The relationship between income and spending can be described by using a hypothetical example of a consumer whose disposable income is 3000 US dollars and would like to buy a washing machine and a car. The prices of the washing machines he has enquired ranges from 1000 to 2400 US dollars while the prices of the cars vary from 1500 to 4000 US dollars.
If the consumer decided to spend all of his disposable income on the two items, he would have to choose a consumption bundle that allows him to derive maximum utility when buying the two items. If his income was higher than 3000 dollars he would have bought the best quality washing machine and still have enough for a car of his dreams but since his income is 3000 dollars only he has to make a choice on buying items which fit on his disposable income thus affecting the extent to which the consumer can spend.
Another factor which reduces or increases the purchasing power of a consumer is the price of commodities. When prices of commodities increase without the consumer income increasing, it leads to reduction of disposable income indirectly.
This can be explained by the fact that the consumer purchasing power is reduced since he has to buy less number of the same quantity or forego other items he would have bought in order to buy the same number of items. Consumer spending is expected to increase if the prices of commodities are low since it gives the consumer the incentive of affording more while still using the same amount of money.
It is a fact that to many it is just an illusion that they are rational consumers. As a matter of fact, one of the most controversial and less understood determinants of consumers spending is their emotions. Recent studies have indicated that customers make varying economic decisions according to their moods for example angry moods can make a consumer stick to his spending preferences while chances of overlooking the spending preference are higher in happy among happy consumers.
A study from the Journal of Consumer Research found out that “Angry consumers were 37% more likely to stick with their existing choices than sad individuals. In other words, angry individuals are less likely to see the advantages or benefits of a new product or service.
People in an irritable or angry mood become cognitively rigid, which is to say, their neural nets are knotted. Until they calm down, new information will be ignored” (Garg, Inman, & Mittal: 2005 par 2). Thus emotions affect consumer spending in a great way though many may not attest to this.
Economic experts claim that confidence among consumers can improve aggregate demand thus improving spending. When the economy of a country is in its down fall as it was happening in the United States of America during the Economic crisis, it results in job losses and decreases in salaries earned. With the disposable income available for spending decreased, households look for goods and services which have lower prices so that the income they have can cater for the expenses likely to be incurred.
If consumers assume that a bad economic condition is likely to be experienced they reacts to this by reducing their spending so as to save more money, which will be used during the anticipated crisis period.
Thus, it is necessary for any government to enact polices, which maintain a comfortable economic condition so as to ensure the consumers remain confident and thus spend more for the reason that as concluded by John Maynard Keynes in his paradox of thrift theory consumer spending is good for the country’s economy and thus if the consumers reduce their spending, the economy of the country also suffers. A good economic condition leads to an increased aggregate demand which in return increases consumer spending.
Interest Rates and the Availability of Credit
Interests can increase or decrease consumer spending depending on how they are used. For example, if a consumer was spending his income on buying a mortgage, low interest rates reduce mortgage interests thus increasing the disposable income available for the consumer to spend on fulfilling other needs.
The low interest rates also make borrowing from lending institutions cheaper therefore reducing the incentive to save. Low interest rates means returns from savings is low and thus consumers are likely to invest more of their money in various investments rather than on savings.
The availability of credit from lending institutions, such as, banks is another major factor that influences consumer spending both in the United States and other places. If lending institutions are reluctant in giving loans for buying commodities such as in purchase of a piece of land, spending on land decreases thus reducing consumer spending but if the bank offered credit readily to consumers this would increase spending in investments such as land leading to increased spending.
Changes in Household Financial Wealth
Wealth and consumer spending relationship is of interest to many economists for example “Traditional macro econometric models estimate that a dollar’s increase in household wealth boosts consumer spending by 3 to 7 cents per year” (McCluer, 1998:2).
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With the above evidence it is possible to state the fact that with increased wealth, consumer spending is also likely to increase. Increased wealth increases consumer spending and low savings in return. However, it is difficult to pin point wealth alone as a factor influencing spending because it has to move together with high income growth and favorable market conditions in order for it to boost spending
Government influences consumer spending both through fiscal policies and monetary policies. Monetary policies influence the supply of money in the money market with these policies aimed to find ways through which the government funds its budget. Stabilizing both forms of policies affect the spending of most consumers, for example, the use of expansionary monetary policy to lower interest rates makes government treasuries or securities less attractive instruments to trade in and this in return leads to increase in stock prices.
These low interests caused by the increased money supply in the market makes financing of investments such as housing cheaper and this increases spending among the consumers. Fiscal policies involve the use of taxes which by an increase cuts down the consumer spending while reducing of taxes increases consumer spending.
For example an introduction of a new tax reduces spending since it leads to an increase in price of the good or service, which makes consumers spend less on the commodity or look for cheaper commodities thus reducing the spending on the commodity.
The Influence of Technology
Any improvement in a technology leads to changes in production and consumption trends. These changes are commonly referred to as rebound effects. There are many types of rebound effects and they include; time, space, technology money or price rebounds. For our case we shall mainly concentrate on price rebound. Price rebound occurs if the change in technology is more costly or cheaper than the previous technology by evaluating its effect on consumer spending.
If the technology leads to reduced production costs to the manufacturer this in return leads to cheaper prices for the commodities produced. The consumers tend to spend more in the reduced price commodity due to the fact that the utility gained is high compared to spending more in a commodity which is costly and serving the same purposes since it does not give the consumers chances to expand their market baskets.
Technologies also lead to production of better quality products. This influences consumer spending in that though the increased quality is likely to lead into increased commodity prices the desire by the consumer to have the best forces him or her to spend more on the commodity.
Changing Household Structures
Household structure changes leads to change in spending. Changes in household structures can occur through change of neighborhoods or change in household sizes. While change in household size effect is easily understood for example if a young family spent all its money for clothing and other basic needs, an introduction of a new born baby comes with its new expenses and thus changes in spending ways.
In the past, the young family was never concerned about tuition fees but as the child grows money will need to be saved in order to ensure the child leads a normal life just like the others; this calls for spending and thus reduced spending. When households change their neighborhoods contrary to the fact that many claim to be rational, indifferent and independent how their neighbors spend is also likely to lead to new spending ways due to the adoption of the new living lifestyles in the new neighborhood.
From this study we can conclude that there are many factors that influence consumer spending or decision making processes. These factors include personal income and government policies among others. To ensure that the consumer derives maximum utility from his income, correct decision making process is a necessary etiquette as we have noted that consumers are limited to spending by the income they earns.
Garg, N., Inman, J., & Mittal, V. (2005). Incidental and Task-Related Affect: A Re-Inquiry and Extension of the Influence of Affect on Choice. Journal of Consumer Research, 32 (1), 154-159.
Mankiw, G. (1998). Microeconomics. New York: Elsevier Publishers.
McCluer, M. S. (1998). Stock Market Wealth and Consumer Spending. Web