What is Consumption in Economics? - Definition & Theory

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  • 0:02 Importance of Consumption
  • 1:08 Theories
  • 4:30 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn what consumption is and how you participate every day in this activity. Find out why it is important and what variables drive the theories behind consumption. Discover some common ways to increase consumption.

The Importance of Consumption

Every time you purchase food at the drive-thru or pull out your debit or credit card to buy something, you are adding to consumption. Consumption is one of the bigger concepts in economics and is extremely important because it helps determine the growth and success of the economy. Businesses can open up and offer all kinds of great products, but if we don't purchase or consume their products, they won't stay in business for very long! If they don't stay in business, many of us won't have jobs or the income to buy goods and services.

Consumption can be defined in different ways, but it is best described as the final purchase of goods and services by individuals. The purchase of a new pair of shoes, a hamburger at the fast food restaurant or services, like getting your house cleaned, are all examples of consumption. It is also often referred to as consumer spending. Many topics in economics explore how the income of families and individuals affects consumption and spending habits.

Theories on Consumption

There are many different theories on income and consumption behavior, and we will focus on some of the more mainstream concepts in consumption theory.

Keynesian Theory and Real Income

One of the most popular and well-known theories is the Keynesian theory, offered by economist John Maynard Keynes. This theory states that current real income is the most important determinant of consumption in the short run. Simply said, you spend according to how much income you have coming in. This is the basis for most consumption theory.

The term 'real' that is used in describing income refers to how your income is affected by inflation, or the natural rise in prices of goods and services. So to elaborate, if your income went up five percent in a year, but the price of goods or inflation went up five percent also, your real income remained flat. You can't really buy or consume any more goods than you could before.

States Affecting Consumption

So what else do economists believe affects consumption and your decision to purchase products and services, besides your real income?

  • Prices - If prices are higher, then a person's total level of consumption will be lower, because consuming will use up a higher percentage of a person's income.
  • Taxes - As taxes on goods and services (sales taxes) rise, people may not be able to afford as much as they used to and, as a result, will consume less. The income tax rates you pay also affect your ability and decision to consume. Higher tax rates lead to less disposable income, which is money you have left over for spending and savings after you pay taxes.
  • Saving - People generally have two things they can do with their money. They can save or they can spend. The more money people save, the less they have to consume in the short-run.
  • Consumer confidence - If people are worried about the economy or their own future income, they may delay making purchases in order to provide some safety and extra cash for future expenses. They will save or delay their consumption until they feel better about what lies ahead.

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