The following article will guide you about the top nine factors determining consumption spending. The factors are: 1. Income distribution 2. The rate of interest 3. Liquid assets and wealth 4. Expected future income 5. Sales effort 6. Capital gains 7. Consumer credit 8. Fiscal policy 9. Other factors.
Factor # 1. Income Distribution:
Keynes believed that the MPC of low income groups would be higher than that of high income groups. So, aggregate demand could be stepped up by a policy of income redistribution — i.e., transferring income from the rich to the poor.
Changes in the distribution of income may alter consumption demand if high-income households consume a smaller proportion of disposable income than do low-income households. If national income were redistributed toward low-income households having a larger propensity to consume, the aggregate consumption schedule would rise, while a less equal redistribution of income would have the opposite effect for similar reasons.
The impact of income redistribution on consumption expenditures is not unambiguous, however. If higher-income groups spend a large portion of their income to “keep up with the Joneses,” income redistribution in favour of low- income households will have an uncertain impact on the consumption schedule.
Factor # 2. The Rate of Interest:
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It has long been supposed that an increase in the rate of interest would lead to an increase in savings and, therefore, a reduction in consumption.
Other things remaining the same, the lower the real interest rate, the greater is the amount of consumption expenditure and the smaller is the amount of saving. The real interest rate is the opportunity cost of consumption.
This opportunity cost arises regardless of whether a person is a borrower or a lender. For a borrower, increasing consumption this year means paying more interest next year. For a lender, increasing consumption this year means receiving less interest next year.
The effect of the real interest rate on consumption expenditure is an example of the principle of substitution. If the opportunity cost of an action increases, people substitute other actions in its place. In this case, if the opportunity cost of current consumption and substitute future consumption in its place.
Factor # 3. Liquid Assets and Wealth:
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Both the supply of liquid assets (money, securities, or bonds) and the wealth represented by existing quantities of durable goods may influence consumer expenditures.
Consider liquid assets first. Many observers contend that a greater stock of liquid assets enhances feelings of economic security and may thereby prompt greater consumption expenditures.
Factor # 4. Expected future income:
The higher a household’s expected future income, other things remaining the same the greater is its consumption expenditure. That is, if two households have the same disposable income on consumption goods and services.
Factor # 5. Sales Effort:
An increase or decrease in the amount of sales effort may affect the total volume of consumer expenditures, given the level of income. Advertising has the effect of shifting demand from one product to another. But, as Ackley has put it, whether as a result of advertising, aggregate consumption, expenditure will fall or not is debatable. It is the matter of empirical (statistical) test and verification.
Factor # 6. Capital Gains:
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Keynes also recognised that consumption spending might be influenced not only by income but by capital gains.
Factor # 7. Consumer Credit:
The terms of consumer credit have often been important in influencing consumption behaviour in respect of durable goods like automobiles, TV sets, radios, etc.
The extent to which consumers can borrow to finance purchases may affect their levels of consumption. The demand for durable goods like appliances and automobiles is particularly sensitive to the availability of credit, because such goods involve sizable expenditures.
A high level of debt may dampen consumer demand, because repayment in the future will be necessary, making less funds available for current consumption. In addition, interest rate levels, the maximum time period for repayment, down-payment requirements, and the ease of access to financial institutions may cause consumer spending for durable goods to increase or decrease.
Factor # 8. Fiscal Policy:
Tax and transfer payments also affect consumption. An increase in indirect taxes raise commodity prices and may lead to a fall in the demand for the taxed commodity. Likewise an increase in income tax may reduce the disposable income of individuals and may lower total consumption expenditure.
Factor # 9. Other Factors:
These include certain motives to consumption such as enjoyment, short-sightedness, generosity, miscalculation, ostentation and extravagance. Keynes calls these subjective factors.
Conclusion:
Although consumption and saving are influenced by several factors, we focus on two of them: the real interest rate and disposable income. The real interest rate, which is the opportunity cost of consumption cost of consumption, determines the long-run allocation of disposable income between consumption and saving. Disposable income is the key short run influence on consumption and saving.
It may also be noted that since consumption and saving are two mirror image concepts, all the factors which determine consumption spending are also the determinants of saving behaviour. If and when there is a change in income there is movement along the consumption line. But if there is a change in any other variable the whole consumption line will shift to a new position.