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Consumer Spending

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Economics

Did you know that consumer spending accounts for almost 70% of the overall economy in the United States,1 and a similarly high percentage in many other countries? With such an enormous impact on economic growth and the strength of a nation, it would be wise to understand more about this vital component of the overall economy. Ready to learn more about consumer spending? Let's get started!

Consumer spending definition

Have you ever heard on TV or read in your news feed that "consumer spending is up", that "the consumer is feeling good", or that "consumers are opening up their wallets"? If so, you may have been wondering, "What are they talking about? What is consumer spending?" Well, we're here to help! Let's start off with a definition of consumer spending.

Consumer spending is the amount of money individuals and households spend on final goods and services for personal use.

Another way to think about consumer spending is any purchases that are not made by businesses or governments.

Consumer spending examples

There are three categories of consumer spending: durable goods, nondurable goods, and services. Durable goods are things that last a long time, such as TVs, computers, cell phones, cars, and bicycles. Nondurable goods include things that don't last very long, such as food, fuel, and clothing. Services include things like a haircut, plumbing, TV repair, auto repair, medical care, financial planning, concerts, travel, and landscaping. To put it simply, goods are given to you in exchange for your money, whereas services are done for you in exchange for your money.

Consumer Spending Consumer Spending Examples StudySmarterComputer, iPad, Phone; pixabay.com

Consumer Spending Consumer Spending Examples StudySmarterWashing Machine; pixabay.comConsumer Spending Consumer Spending Examples StudySmarterCar; pixabay.com

One might think a house would be a durable good, but that is not the case. While buying a house is for personal use, it is actually considered an investment and is included in the category of Residential Fixed Investment for the purposes of calculating Gross Domestic Product in the United States.

A computer is considered consumer spending if it is purchased for personal use. However, if it is purchased for use in a business, it is considered an investment. In general, if a good is not used later in the production of another good or service, the purchase of that good is considered consumer spending. In the United States, when a person buys a good that is used for business purposes, they can often deduct those expenses when filing their tax returns, which can help to reduce their tax bill.

Consumer spending and GDP

In the United States, consumer spending is the largest component of the economy, otherwise referred to as Gross Domestic Product (GDP), which is the sum of all final goods and services produced in the country, given by the following equation:

With consumer spending accounting for around 70% of GDP in the United States,1 it is clear that it is very important to keep an eye on consumer spending trends.

As such, the Conference Board, a United States government agency that collects all kinds of economic data, includes manufacturers' new orders for consumer goods in its Leading Economic Indicators Index, which is a compilation of indicators that is used to try to predict future economic growth. Thus, consumer spending is not only a huge component of the economy, it is also a key factor in determining how strong economic growth may be in the near future.

Consumption Spending Proxy

Since personal consumption expenditures data is only reported quarterly as a component of GDP, economists closely follow a subset of consumer spending, known as retail sales, not only because it is reported more frequently (monthly) but also because the retail sales report breaks down sales into different categories, which helps economists determine where there is strength or weakness in consumer spending.

Some of the largest categories include vehicles and parts, food and beverages, non-store (online) sales, and general merchandise. Thus, by analyzing a subset of consumer spending on a monthly basis, and just a few categories within that subset, economists have a pretty good idea about how consumer spending is faring long before the quarterly GDP report, which includes personal consumption expenditures data, is released.

Consumer Spending Calculation Example

We can calculate consumer spending in a couple of ways.

We can derive consumer spending by rearranging the equation for GDP:C = GDP - I - G - NXWhere:C = Consumer SpendingGDP = Gross Domestic ProductI = Investment SpendingG = Government SpendingNX = Net Exports (Exports - Imports)

For example, according to the Bureau of Economic Analysis,1 we have the following data for the fourth quarter of 2021:

GDP = $19.8T

I = $3.9T

G = $3.4T

NX = -$1.3T

Find consumer expenditure in the fourth quarter of 2021.

From the formula it follows that:

C = $19.8T - $3.9T - $3.4T + $1.3T = $13.8T

Alternatively, consumer spending can be approximated by adding the three categories of consumer spending:C = DG + NG + SWhere:C = Consumer SpendingDG = Durable Goods SpendingNG = Nondurable Goods SpendingS = Services Spending

For example, according to the Bureau of Economic Analysis,1 we have the following data for the fourth quarter of 2021:

DG = $2.2T

NG = $3.4T

S = $8.4T

Find consumer expenditure in the fourth quarter of 2021.

From the formula it follows that:

C = $2.2T + $3.4T + $8.4T = $14T

Wait a minute. Why isn't the value for C calculated using this method not the same as the value calculated using the first method? The reason has to do with the methodology used to calculate the components of personal consumption expenditures, which is beyond the scope of this article. Still, it is a pretty close approximation to the value obtained using the first method, which should always be used if the data is available.

Impact of recession on consumer spending

The impact of a recession on consumer spending can vary widely. All recessions occur because of an imbalance between aggregate supply and aggregate demand. However, the cause of a recession can often determine the impact of a recession on consumer spending. Let's examine further.

Demand Grows Faster Than Supply

If demand grows faster than supply - a rightward shift of the aggregate demand curve - prices will move higher, as you can see in Figure 1. Eventually, prices get so high that consumer spending either slows or declines.

Consumer Spending Impact of Recession on Consumer Spending StudySmarterFigure 1. Rightward Aggregate Demand Shift - StudySmarter

To learn more about different causes of aggregate demand shifts check our explanations on - Aggregate Demand and Aggregate Demand Curve

Supply Grows Faster Than Demand

If supply grows faster than demand - a rightward shift of the aggregate supply curve - prices tend to either remain fairly steady or decline, as you can see in Figure 2. Eventually, supply gets so high that companies need to slow hiring or outright let go of employees. In time, this may lead to a decline in consumer spending as personal income expectations fall due to fear of job loss.

Consumer Spending Impact of Recession on Consumer Spending StudySmarterFigure 2. Rightward Aggregate Supply Shift - StudySmarter

To learn more about different causes of aggregate supply shifts check our explanations on - Aggregate Supply, Short-Run Aggregate Supply and Long-Run Aggregate Supply

Demand Falls Faster Than Supply

Now, if demand falls faster than supply - a leftward shift of the aggregate demand curve - it can be due to a decline in consumer spending or investment spending, as you can see in Figure 3. If it's the former, then the mood of consumers may actually be the cause of, rather than the consequence of, a recession. If it's the latter, consumer spending will likely slow as a decline in investment spending usually leads to a decline in consumer spending.

Consumer Spending Impact of Recession on Consumer Spending StudySmarterFigure 3. Leftward Aggregate Demand Shift - StudySmarter

Supply Falls Faster Than Demand

Finally, if supply falls faster than demand - a leftward shift of the aggregate supply curve - prices will rise, as you can see in Figure 4. If prices rise slowly, consumer spending may slow. However, if prices rise quickly it could actually lead to stronger consumer spending as people rush to buy goods and services before prices rise even further. Eventually, consumer spending will slow as those previous purchases were, in essence, pulled from the future, so future consumer spending will be lower than otherwise would have been the case.

Consumer Spending Impact of Recession on Consumer Spending StudySmarterFigure 4. Leftward Aggregate Supply Shift - StudySmarter

As you can see in Table 1 below, the impact of a recession on consumer spending has varied during the last six recessions in the United States. On average, the impact has been a 2.6% decline in personal consumption expenditures.1 However, that includes the very large and rapid decline during the short-lived recession in 2020 due to the shutting down of the global economy as COVID-19 shocked the world. If we remove that outlier, the impact has been only slightly negative.

In summary, it is possible to have a recession without a large, or even any, decline in consumer spending. It all depends on what caused the recession, how long and how bad consumers expect the recession to be, how concerned they are about personal income and job losses, and how they react to it with their wallets.

Years of RecessionMeasurement PeriodPercent Change During Measurement Period
1980Q479-Q280-2.4%
1981-1982Q381-Q481-0.7%
1990-1991Q390-Q191-1.1%
2001Q101-Q401+2.2%
2007-2009Q407-Q209-2.3%
2020Q419-Q220-11.3%
Average-2.6%
Average Excluding 2020-0.9%

Table 1. Impact of recession on consumer spending between 1980 and 2020.1

Consumer spending chart

As you can see in Figure 5. below, consumer spending has a strong correlation with GDP in the United States. However, consumer spending has not always declined during a recession. The cause of a recession determines how consumers will react to a decline in GDP, and consumers can sometimes be the cause of a recession as they pull back spending in anticipation of falling personal incomes or job losses.

It is clear that personal consumption expenditures declined noticeably during the Great Recession of 2007-2009 and during the pandemic-induced recession of 2020, which was a massive and rapid shift left in the aggregate demand curve due to government-imposed lockdowns across the entire economy. Consumer spending and GDP then both rebounded in 2021 as the lockdowns were lifted and the economy opened back up.

Consumer Spending Consumer Spending Chart StudySmarterFigure 5. U.S. GDP and Consumer Spending - StudySmarter. Source: Bureau of Economic Analysis1

In the chart below (Figure 6), you can see that not only is consumer spending the largest component of GDP in the United States, but its share of GDP has been increasing over time. In 1980, consumer spending accounted for 63% of GDP. By 2009 it had risen to 69% of GDP and stayed around this range for several years before jumping to 70% of GDP in 2021. Some factors leading to a higher share of GDP include the advent of the internet, more online shopping, and globalization, which has, until recently, kept consumer goods prices low and thereby more affordable.

Figure 6. U.S. Consumer Spending Share of GDP - StudySmarter. Source: Bureau of Economic Analysis1

Consumer Spending - Key takeaways

  • Consumer spending is the amount of money individuals and households spend on final goods and services for personal use.
  • Consumer spending accounts for about 70% of the overall United States economy.
  • There are three categories of consumer spending; durable goods (cars, appliances, electronics), non-durable goods (food, fuel, clothing), and services (haircut, plumbing, TV repair).
  • The impact of a recession on consumer spending can vary. It depends on what caused the recession and how consumers react to it. Moreover, it is possible to have a recession with no decline in consumer spending at all.
  • Consumer spending has a strong correlation with GDP in the United States, and its share of GDP has risen over the last few decades.

1. Source: Bureau of Economic Analysis (National Data-GDP & Personal Income-Section 1: Domestic Product and Income-Table 1.1.6)

Consumer Spending

Consumer spending is the amount of money individuals and households spend on final goods and services for personal use.  

The Great Depression was caused by a massive decline in investment spending in 1930. In contrast, the decline in consumer spending was a lot smaller on a percentage basis. In 1931, investment spending plunged further, while consumer spending only fell by a small percentage. 


Throughout the entire Depression from 1929-1933, the bigger dollar decline came from consumer spending (because consumer spending is a much larger share of the economy), while the bigger percentage decline came from investment spending.


We can calculate consumer spending in a couple of ways.


We can derive consumer spending by rearranging the equation for GDP:


C = GDP - I - G - NX


Where:

C = Consumer Spending

GDP = Gross Domestic Product

I = Investment Spending

G = Government Spending

NX = Net Exports (Exports - Imports)


Alternatively, consumer spending can be calculated by adding the three categories of consumer spending:


C = DG + NG + S


Where:

C = Consumer Spending

DG = Durable Goods Spending

NG = Nondurable Goods Spending

S = Services Spending


It must be noted that using this method will not result in the same value as using the first method. The reason has to do with the methodology used to calculate the components of personal consumption expenditures, which is beyond the scope of this article. Still, it is a pretty close approximation to the value obtained using the first method, which should always be used if the data is available.

Unemployment affects consumer spending negatively. Consumer spending generally declines when unemployment increases, and rises when unemployment falls. However, if the government provides enough welfare payments or unemployment benefits, consumer spending may hold steady or even increase despite high unemployment.

The relationship between income and consumer spending is known as the consumption function:

 

C = A + MPC x YD

 

Where:

C = Consumer Spending

A = Autonomous Spending (vertical intercept)

MPC = Marginal Propensity to Consume

YD = Disposable Income

 

Autonomous spending is how much consumers would spend if disposable income was zero. 

 

The slope of the consumption function is MPC, which represents the change in consumer spending for every $1 change in disposable income.

Final Consumer Spending Quiz

Question

Define consumer spending

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Answer

Consumer spending is the amount of money individuals and households spend on final goods and services for personal use. 

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Question

Consumer spending accounts for approximately how much of the U.S. economy?

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Answer

30%

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Question

Which of the following is not a category of consumer spending?

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Answer

Durable goods

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Question

Appliances are an example of durable goods.

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Answer

True

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Question

Fuel is an example of

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Answer

Durable goods

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Question

The purchase of a house is considered

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Answer

Consumer spending

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Question

Demand for consumer goods is a good predictor of economic growth

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Answer

True

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Question

Economists follow which indicator as a proxy for consumer spending?

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Answer

Home sales

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Question

If demand falls, prices generally

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Answer

Decrease

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Question

Over the last few decades, consumer spending as a share of GDP has 

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Answer

Increased

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Question

A decline in consumer spending is always the cause of a recession.

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Answer

True

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Question

Which of the following is not an example of consumer spending?

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Answer

Car

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Question

Prices generally rise when

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Answer

Demand falls

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Question

Which of the following might cause consumer spending to increase?

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Answer

Higher unemployment rate

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60%

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