THeory of Consumption and Economy

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 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 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?

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Economic Theory

 Economic theory is a broad concept for the explanation and understanding of the movement of goods in a market. Theoretical economic concepts typically have scientific backing or studies to prove or disprove a stated hypothesis. National governments also have an interest in theories of economics. Politicians rely on studies of government spending, tax collections, money supply, and consumer spending data to make laws or set policy. Different economic theories exist that focus on different aspects of government policy regarding economics.

Many economies have their own views about that, for example TW. Swan and Robert Solow. they talks more about the growth on economy.

             Two economists, T.W. Swan and Robert Solow, made important contributions to economic growth theory in developing what is now known as the Solow-Swan growth model. The theory focuses on three factors that impact economic growth: labor, capital, and technology, or more specifically, technological advances. The output per worker (growth per unit of labor) increase with the output per capital (growth per unit of capital) but at a decreasing rate. This is referred to as diminishing marginal returns. Therefore, there will become a point at which labor and capital can be set to reach an equilibrium state.