Which Economic Factors Most Affect the Demand for Consumer Goods?

The consumer goods sector includes a wide range of retail products purchased by consumers including staples such as food and clothing to luxury items such as jewelry and electronics.

Overall demand for food isn’t 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, however. The economic factors that most affect the demand for consumer goods are employment, wages, prices/inflation, interest rates, and consumer confidence.

Key Takeaways

• Consumer goods are those 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.
• The demand for consumer goods increases when employment, wages, and consumer confidence are high.
• The demand for consumer goods decreases When inflation or interest rates are high.

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. The monthly unemployment rate report is therefore one economic leading indicator that gives clues to demand for consumer goods.

The level of wages also affects consumer spending. Consumers generally have more discretionary income to spend if wages are steadily rising. Demand for optional consumer goods is likely to fall when wages are stagnant or dropping. Median income is one of the best indicators of the condition of wages for American workers.

Prices and Interest Rates

Prices are affected by the rate of inflation so they significantly impact consumer spending on goods. The producer price index (PPI) and the consumer price index (CPI) are considered leading economic indicators for this reason.

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 substantially impact the level of spending on consumer goods. 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.

Important

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.

Demand for consumer goods increases overall when the economy that’s 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

The term “invisible hand” is used in economics 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 that promotes the general welfare of society at large, which was not part of their intention.

Note

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.

All voluntary economic exchanges require each party to believe that it benefits in some way, even psychologically, and every consumer and producer has competitors to contend with so 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. Consumers indirectly inform producers about what goods and services to provide through competition for scarce resources and in what quantity they should be provided. Consumers tend to receive cheaper, better, and more goods and services over time as a result of their collective demands, preferences, and spending.

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.

Important

Inelastic goods are those whose demand doesn’t change regardless of changes in prices such as medication necessary for serious diseases.

Consumers express value to producers through decisions about what to buy and what not to buy and at what prices those exchanges are acceptable. Producers then compete with each other 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.

Explain Like I’m 5

Assume your vehicle is well up there in years and it’s on its last legs. You can’t meet the responsibilities of your daily life without a car so you decide it’s time to buy a new one. This is a discretionary purchase to some extent because you could technically walk or call for a rideshare to get where you and your family have to go.

Then you lose your job. Your lack of employment will no doubt make it impossible for you to qualify for an auto loan, not to mention that you’d have a hard time making those payments while you’re collecting unemployment compensation. Your loss of employment has affected the demand for at least one automobile.

Now assume that your employer terminated your position because the economy has deteriorated to a point where the company just can’t afford you anymore. And it’s not just your company. It’s happening all over America. Consumer demand for new autos will certainly plummet until the economy and the unemployment rate recover. Higher interest rates on those cars will also affect demand.

What’s the Difference Between Cyclical Goods and Noncyclical Goods?

Noncyclical goods are those that will always be in demand because they’re always needed. They include food, pharmaceuticals, and shelter. Cyclical goods are those that aren’t 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. A country’s central bank usually seeks to reduce it to acceptable levels when inflation exists in an economy. It will increase interest rates to reduce inflation.

Increased interest rates make the price of goods and services more expensive because borrowing money becomes more expensive. When goods and services are more expensive. The demand for goods and services decreases, eventually reducing the price and curbing inflation.

Which Economic Indicator Measures Consumer Spending?

Consumer spending is measured by the personal consumption expenditures (PCE) indicator 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. The demand for consumer goods will increase when the economy is healthy: employment is strong, wages are high, interest rates are low, inflation is low, and consumer confidence is positive.