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 a number of economic factors. The economic factors that most affect the demand for consumer goods are employment, wages, prices/inflation, interest rates and consumer confidence.
How Employment and Wages Affect Consumer Goods Demand
One of the main factors influencing 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. (For related reading, see: What Is the Average Income in the U.S.?)
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.
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 about 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 corresponding growth in the demand for goods and services. (For related reading, see: What factors affect the performance of the consumer packaged goods industry?)
The Effect of 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.
What is 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.
Professor Karen Vaughn of George Mason University described the impact of the invisible hand this way: "The invisible hand was Smith's metaphor for describing the mutually beneficial aspect of trade in an exchange economy that emerged as the unplanned consequences of the prosecution of individual plans."
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
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. 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 to provide those goods and services to consumers for a 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.