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The Nonincome Determinants of Consumption Spending

Although consumption spending is determined primarily by the level of disposable income, nonincome factors also play a role. These nonincome factors include (1) people's expectations about what will happen to prices and to their incomes, (2) the cost and availability of consumer credit, and (3) the overall wealth of households.

It is easy to see why consumer expectations can have an impact on spending behavior. If people expect prices to be higher next month or next year, they tend to buy now. Why wait to pay $14,000 for a car next year if you can buy it for $13,000 today? Buying now to avoid higher prices later creates a greater amount of current consumption spending than would normally be expected at each level of income. Similarly, if people expect an increase in income, they will probably spend more from their current income. If you're convinced that you're going to be earning more next year, you'll probably be a little bit freer in your spending habits this year.

The cost and availability of consumer credit also influence the level of consumption spending. Most of us don't limit our spending to our current income. If we really want something, we borrow the money to buy it. But the cost of borrowing money and the ability to get consumer credit can change with the state of the economy. In general, the higher the interest rate and the more difficult it is to get consumer loans, the less consumption spending there will be at any level of total income (GDP).

The third nonincome determinant of consumption spending is the overall wealth of households. A household's wealth includes cash, bank accounts, stocks and bonds, real estate, and other physical assets. Since households can finance consumption spending by depleting bank accounts or selling other forms of wealth, an increase in wealth will permit households to spend more at any given income level. For this reason, an increase in wealth will tend to shift the consumption function upward; a decrease will have the opposite effect.

The consumption function assumes that these nonincome determinants of consumption spending remain unchanged. If that assumption is violated, the entire consumption function shifts. Exhibit 3 shows how changing expectations about prices result in different levels of planned consumption spending at each level of income.

EXHIBIT 3. Changes in the Nonincome Determinants of Consumption

Changes in the Nonincome Determinants of Consumption

Except under extreme conditions, such as those that prevailed during the Great Depression or World War II, the consumption function has been relatively stable; it hasn't shifted up or down very much. Knowing that planned consumption has been stable, how do we explain the fluctuations in total spending that occur in our economy? According to Keynes, the major cause of fluctuations in total spending is the ever-changing rate of investment spending.

 
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