A blog by Aditya Diwakar and Aman Ganguli
What X is to a Mathematician Y is to an Economist !
Y in Economics is used to denote Income and most discussions in Macro and Micro Economics are incomplete without Income.
What do you think is the main reason behind earning income?
It’s CONSUMPTION due to which the bare sustenance of life is carried about.
Consumption in Economics is a more general term rather than just the consumption of food items which happens to be the only form of consumption layman knows of.
Consumption in Economics is defined as the use of goods and services (produced by the producers), mainly by the Households to satisfy their basic wants and need. For example – If you are going to a store to buy your monthly food item and use public transport, then the money you pay for using that public transport is also a part of consumption. Further, imagine while coming back from the store to your house you were hit by a motor vehicle and suffered minor injuries. You go to a doctor and get your first aid done. The money you paid to the doctor for his services is also a part of your consumption.
In this blog, we focus on how the income of the entire economy is used. An economy comprises of four sector
1.Household -We refer to the consumption of the household sector as Household Consumption or Simply Consumption denoted by letter C
2.Private Sector –We refer to the expenditure of the Private Sector as Investment and denoted by letter I.
3. Government Sector- We refer to the expenditure of the Government Sector as Government Expenditure and denote it by letter G.
4. Foreign Sector – This sector includes the expenditure on the good that is produced outside of our country called Export denoted by letter X minus the goods produced inside our country but is sold to the rest of the world called Imports denoted by letter M.
Thus, we arrive at the National Income formula:
Y= C+ I + G + NX
Y- National Income
G- Government Expenditure
NX- Net Exports (Exports-Imports)
Consumption or Household Consumption:
Households constitute the largest sector of consumption in an Economy. It consists of people like you and us. This sector includes the entire, wants-and-needs-satisfying, eating, breathing, consuming population of the economy. In a word, it includes everyone, all consumers, all people, and every member of society. The contribution of Household consumption to the National Income is maximum in an Economy. Examples include the purchase of food items from the departmental store; availing the services of a doctor; expenditure on public transport. It also includes the money you pay to avail the services of Reliance Jio or the money with which you purchased Tata Nano.
Investment: Investment is done by the private sector in an economy. The private sector includes small and large industries. It consists of people like Ambani, Adani, Ratan Tata or the owner of the factory near your village. Expenditure on goods which are further used for the production of other goods and services is known as Investment. Investment plays a crucial role in the development of an Economy. Examples of investment include – The expenditure incurred by Reliance Digital in setting up the entire mechanism to provide Reliance Jio Internet Connectivity or by Tata for setting up the plants and machinery used in the production of the car Tata Nano.
Government Expenditure: This sector includes the expenditure undertaken by the various levels of the government i.e. Central, State and Local. The Government incurs expenditure on the procurement of goods required for public welfare. For example, the expenditure incurred by the government on the purchase of medicines for government hospitals or books for government schools. Other examples include the purchase of arms and ammunition like fighter jets such as Rafale or by the state government on building state highways or by local government on the drainage system.
Net Exports: In the 21st century, every Economy is an Open Economy, i.e. there is a free flow of goods, services and capital between countries without restrictions. The countries earn Income for the export of domestically produced goods while incurring expenditure on the import of foreigner goods. The difference between the income earned and the expenditure incurred is called the net exports of an Economy. If the imports exceed the exports, the term is negative while if the exports exceed the imports, net exports are positive. The term net export is also known as the Balance of payments of an Economy. Example of export is the money our country (India) receives by selling Tomato to Pakistan while an example of import would be the money you spend on buying a mobile phone of brands like One Plus or Samsung.
- Veblen Consumption: The consumption of goods in order to create a sense of sophistication, a feeling of show off is known as Veblen Consumption and the goods are known as Veblen Goods. For example; Higher the price of a diamond ring, higher the value it holds to a person who is willing to purchase it to mark his/her status.
The consumption pattern in an economy is governed by the law of demand which states that the demand for a good is inversely related to its price. There are some special cases of consumer goods we would like to mention, which violate the law of demand.
- Giffen Consumption: Giffen Goods are those which form an essential part of the consumer’s consumption basket and whose demand increases with a rise in its price in a way where the consumer cuts down on the consumption of other goods to compensate for the rise in expenditure. This happened in Ireland when the price of potatoes sky-rocketed. The people cut down on their consumption of meat to keep their demand for potatoes intact.
The goods which are consumed by the aforementioned sectors are termed as consumption goods. These are by-products of goods produced by their counterparts, the producers.