A:

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

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 Georgetown 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.

RELATED FAQS
  1. What does the term 'invisible hand' refer to in the economy?

    Discover and understand the concept of the "invisible hand" as explained by Adam Smith, considered the founder of modern ... Read Answer >>
  2. What is the difference between a capital good and a consumer good?

    Learn to differentiate between capital goods and consumer goods, determined by how those goods are used, and see why capital ... Read Answer >>
  3. What are some limitations of the consumer price index (CPI)?

    Explore some of the basic limitations of the widely used economic indicator, the consumer price index, or CPI, and examine ... Read Answer >>
  4. Consumer Confidence Vs. Consumer Sentiment

    Is there any real difference between consumer confidence and consumer sentiment? Read Answer >>
  5. Is demand or supply more important to the economy?

    Learn more about the impact of supply and demand in an economy. Find out why companies study supply and demand as part of ... Read Answer >>
  6. What causes inflation, and does anyone gain from it?

    In this article, we will examine the fundamental factors behind inflation, different types of inflation and who benefits ... Read Answer >>
Related Articles
  1. Insights

    Why Consumer Confidence Matters

    As consumer spending is a dominant component of the U.S. economy, how consumers feel about the economy can become self-fulfilling.
  2. Insights

    Adam Smith and "The Wealth Of Nations"

    Adam Smith's 1776 classic "Wealth of Nations" may have had the largest global impact on economic thought.
  3. Investing

    Mattel Stock: 4 Things to Watch (MAT)

    Here are the four leading economic indicators that could affect shares of Mattel Inc. in the next six months, but which ones will have the most impact?
  4. Investing

    Consumer Confidence: A Killer Statistic

    The consumer confidence is key to any market economy, so investors need to learn how to analyze them.
  5. Insights

    Consumer Discretionary Sector: Industries Snapshot

    Discover the consumer discretionary sector, industries within this sector and companies producing goods that fall under the consumer discretionary definition.
  6. Investing

    3 Popular Consumer Sector ETFs in 2016 (XLY, XLP)

    Find out which consumer sector exchange-traded funds (ETFs) are the most popular going into 2016 based on the amount of assets under management.
  7. Insights

    How To Read The Michigan Consumer Sentiment Index

    The Michigan Consumer Sentiment Index has provided a key leading indicator for investors and economists for decades. This respected index is published monthly from the results of random telephone ...
  8. Insights

    How Interest Rates Affect The U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds and inflation.
RELATED TERMS
  1. Invisible Hard Market

    An invisible hard market refers to a rising property and casualty ...
  2. Invisible Trade

    Transactions that occur across borders but without the exchange ...
  3. Consumer Discretionary

    Consumer discretionary is an economic sector that comprises items ...
  4. Consumer Goods Sector

    The consumer good sector is a category of stocks and companies ...
  5. Consumer Cyclicals

    Consumer cyclicals are stocks that rely heavily on the business ...
  6. Consumer Credit

    Consumer credit is a debt that someone incurs for the purpose ...
Hot Definitions
  1. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  2. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  3. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  4. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  5. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  6. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
Trading Center