:max_bytes(150000):strip_icc()/GettyImages-1064145406-e0b7e7499d3b4f0da51f97358f770cbd.jpg "Which Economic Factors Most Affect the Demand for Consumer Goods?")
The consumer goods sector includes a wide range of retail products purchased by consumers, from staples such as food and clothing to luxury items such as jewelry and electronics.
While overall demand for food is not likely to fluctuate wildly—although the specific foods consumers purchase can vary significantly under different economic conditions—the level of consumer spending on more optional purchases, such as automobiles and electronics, varies greatly depending on many economic factors.
The economic factors that most affect the demand for consumer goods are employment, wages, prices/inflation, interest rates, and consumer confidence. Below we discuss each in turn.
Key Takeaways
- Consumer goods are goods purchased by consumers, such as food, clothing, cars, electronics, and home goods.
- The demand for some consumer goods increases or decreases depending on many economic factors.
- Economic factors that affect the demand for consumer goods include employment, wages, prices/inflation, interest rates, and consumer confidence.
- When employment, wages, and consumer confidence are high, the demand for consumer goods increases. If they are low, the opposite is true.
- When inflation or interest rates are high, then the demand for consumer goods decreases. The opposite is true if they are low.
Employment and Wages
One of the main factors influencing the demand for consumer goods is the level of employment. The more people there are receiving a steady income and expecting to continue receiving one, the more people there are to make discretionary spending purchases. Therefore, the monthly unemployment rate report is one economic leading indicator that gives clues to demand for consumer goods.
The level of wages also affects consumer spending. If wages are steadily rising, consumers generally have more discretionary income to spend. If wages are stagnant or falling, demand for optional consumer goods is likely to fall. Median income is one of the best indicators of the condition of wages for American workers.
Prices and Interest Rates
Prices, affected by the rate of inflation, naturally impact consumer spending on goods significantly. This is one reason the producer price index (PPI) and the consumer price index (CPI) are considered leading economic indicators.
Higher inflation rates erode purchasing power, making it less likely that consumers have excess income to spend after covering basic expenses such as food and housing. Higher price tags on consumer goods also deter spending.
Interest rates can also impact the level of spending on consumer goods substantially. Many higher-end consumer goods, such as automobiles or jewelry, are often purchased by consumers on credit. Higher interest rates make such purchases substantially more expensive and therefore deter these expenditures.
Higher interest rates generally mean tighter credit as well, making it more difficult for consumers to obtain the necessary financing for major purchases such as new cars. Consumers often postpone purchasing luxury items until more favorable credit terms are available.
The U.S. Federal Reserve targets an annual inflation rate of 2%.
Consumer Confidence
Consumer confidence is another important factor affecting the demand for consumer goods. Regardless of their current financial situation, consumers are more likely to purchase greater amounts of consumer goods when they feel confident about both the overall condition of the economy and their personal financial future.
High levels of consumer confidence can especially affect consumers’ inclination to make major purchases and to use credit to make purchases.
Overall, demand for consumer goods increases when the economy producing the goods is growing. An economy showing good overall growth and continuing prospects for steady growth is usually accompanied by a corresponding growth in the demand for goods and services.
The Invisible Hand of the Market
In economics, the term “invisible hand” is used to describe the mechanisms that lead to spontaneous social benefits in a free market economy.
These processes are “spontaneous” in the sense that they take place without dictate from a central authority, such as the government. The term was taken from a line in Adam Smith’s famous book, “An Inquiry into the Nature and Causes of the Wealth of Nations.”
Milton Friedman, an American economist, and professor at the University of Chicago during the second half of the 20th century, provided perhaps the best-known description of the role of the invisible hand.
Friedman noted that it was “cooperation without coercion” and individual people, guided by their own self-interest, are guided to promote the general welfare of society at large, which was not part of their intention.
Much of the spontaneous order—and many of the benefits—of the market arise from different producers and consumers wanting to engage in mutually beneficial trades.
Since all voluntary economic exchanges require each party to believe it benefits in some way, even psychologically, and because every consumer and producer has competitors to contend with, the overall standard of living is raised through the pursuit of separate interests.
Consumers and the Invisible Hand
Consumers participate in, help guide, and are ultimately some of the benefactors of the invisible hand of the market. Through competition for scarce resources, consumers indirectly inform producers about what goods and services to provide and in what quantity they should be provided.
As a result of their collective demands, preferences, and spending, consumers tend to receive cheaper, better, and more goods and services over time, with all else being equal.
There are two primary mechanisms by which consumers affect—and are affected by—the invisible hand. The first mechanism is initiated through competitive bidding for various goods and services.
Inelastic goods are those whose demand does not change regardless of changes in prices, such as medication needed for serious diseases.
Through decisions about what to buy and what not to buy, and at what prices those exchanges are acceptable, consumers express value to producers.
Producers then compete with one another to organize resources and capital in such a way as to provide those goods and services to consumers for profit. The scarce resources in the economy are continuously rearranged and redeployed to maximize efficiency.
The second major effect arrives through the risk-taking, discovery, and innovations that occur as competitors consistently seek ways to maximize their productive capital.
Increases in productivity are naturally deflationary, meaning consumers can purchase relatively more goods for relatively fewer monetary units. This has the effect of raising the standard of living, affording consumers more wealth even when their incomes remain the same.
What Is the Difference Between Cyclical Goods and Noncyclical Goods?
Noncyclical goods are goods that will always be in demand because they are always needed, such as food, pharmaceuticals, and shelter. Cyclical goods are those that are not that necessary and whose demand changes along with the business cycle. Goods such as cars, travel, and jewelry are cyclical goods.
How Do Interest Rates Affect Inflation?
Rising interest rates usually reduce inflation. When inflation exists in an economy, a country’s central bank usually seeks to reduce it to acceptable levels. In order to reduce inflation, a central bank will increase interest rates.
Increased interest rates make the price of goods and services more expensive because borrowing money becomes more expensive with higher interest rates. When goods and services are more expensive, the demand for them decreases, which eventually reduces the price, curbing inflation.
Which Economic Indicator Measures Consumer Spending?
Consumer spending is measured by the personal consumption expenditures (PCE) indicator which is produced by the Bureau of Economic Analysis (BEA).
The Bottom Line
The economy is a large, interlinked machine functioning on many different levels. Changes in different aspects of the economy affect how consumers spend their money. When the economy is healthy (employment is strong, wages are high, interest rates are low, inflation is low, and consumer confidence is positive) the demand for consumer goods will increase.