Boundless: Marketing: "Consumer Income, Purchasing Power, and Confidence"

Key Points

  • Purchasing power can change if the price of goods increases/decreases, or if inflation increases/decreases. A higher real income means a higher purchasing power since real income refers to the income adjusted for inflation.
  • A CPI can be used to index the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values.
  • if the economy expands causing consumer confidence to be higher, consumers will be making more purchases. On the other hand, if the economy contracts or is in bad shape, confidence is lower, and consumers tend to save more and spend less.


Terms

Consumer confidenceAn economic indicator measuring the degree of optimism that consumers feel about the overall state of the economy and their personal financial situation.

Purchasing powerThe amount of goods and services that can be bought with a unit of currency or by consumers.

Consumer price indexA statistical estimate of the level of prices of goods and services bought for consumption purposes by households.


Consumer Buying Power

A consumer's buying power represents his or her ability to make purchases. The economy affects buying power. For example, if prices decline, consumers have greater buying power. If the value of the dollar increases relative to foreign currency, consumers have greater buying power. When inflation occurs, consumers have less buying power.


Purchasing Power

Purchasing power is the amount of goods or services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s. Currency can be either a commodity money, like gold or silver, or fiat currency, or free-floating market-valued currency like US dollars. As Adam Smith noted, having money gives one the ability to "command" others' labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for money or currency.

If one's monetary income stays the same, but the price level increases, the purchasing power of that income falls. Inflation does not always imply falling purchasing power of one's money income since it may rise faster than the price level. A higher real income means a higher purchasing power since real income refers to the income adjusted for inflation.


Consumer Price Index (CPI)

A consumer price index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. " The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values. In most countries, the CPI is one of the most closely watched national economic statistics.


Consumer Confidence

Consumer confidence is an economic indicator which measures the degree of optimism that consumers feel about the overall state of the economy and their personal financial situation. How confident people feel about stability of their incomes determines their spending activity and therefore serves as one of the key indicators for the overall shape of the economy. In essence, if the economy expands, causing consumer confidence to be higher, consumers will be making more purchases. On the other hand, if the economy contracts or is in bad shape, confidence is lower, and consumers tend to save more and spend less. A month-to-month diminishing trend in consumer confidence suggests that in the current state of the economy most consumers have a negative outlook on their ability to find and retain good jobs.

The ability to predict major changes in consumer confidence allows businesses to gauge the willingness of consumers to make new purchases. As a result, businesses can adjust their operations and the government can prepare for changing tax revenue. If confidence is dropping and consumers are expected to reduce their spending, most producers will tend to reduce their production volumes accordingly. For example, if manufacturers anticipate that consumers will reduce retail purchases, especially for expensive and durable goods, they will cut down their inventories in advance and may delay investing in new projects and facilities. The government will get ready for the reduction in future tax revenues. On the other hand, if consumer confidence is improving, people are expected to increase their purchases of goods and services. In anticipation of that change, manufacturers can boost production and inventories. Large employers can increase hiring rates. Government can expect improved tax revenues based on the increase in consumer spending.

Consumer confidence is formally measured by the Consumer Confidence Index (CCI), a monthly release designed to assess the overall confidence, relative financial health and spending power of the US average consumer. The CCI is an important measure used by businesses, economic analysts, and the government in order to determine the overall health of the economy (see ).


US Consumer Price Index 1913-2006

Since 1980, owing to specific targeting of inflation, the change in the US CPI has mostly stayed below 5% annually.

Last modified: Thursday, July 2, 2015, 3:51 PM