8 Consumer spending

The modern market economy is populated by three types of economic agents, whose interaction constitutes economic activity: consumers, producers, and the government. The main purpose of the economy is to produce goods and services for the satisfaction of the needs of consumers.

Consumers, typically representing households, spend their income to buy consumer goods and services or to save.

How does a consumer distribute the income earned by him amongst a variety of goods and services offered in the market?

There are different factors affecting his decisions. For instance, a fall in the price of a good or service will increase his consumption of it, while a rise in its price will have the opposite effect.

Then a rise in his real income will naturally result in an increased consumption of goods and services, a fall in real income having the opposite effect1.

The pattern of consumer expenditure is also influenced by tastes, consumer preferences and family circumstances. As incomes rise, expenditure on basic goods will form a smaller proportion of total spending. The terms "necessities" and "luxuries" are of little use in analyzing consumer expenditure because what are today's luxuries will probably be tomorrow's necessities.

It should be stressed here, that some customers, however, want to have high-quality products even when quality means a higher price. Some other customers prefer foreign products.

The amount spent on goods and services and changes in this variable have a big impact on the level of economic activity: the increase in consumer spending creates new employment opportunities and causes better living standards.

9 The Big Mac index

Jan 12th 2012, 16:53 by The Economist online

THE ECONOMIST's Big Mac index is based on the theory of purchasing-power parity: in the long run, exchange rates should adjust to equal the price of a basket of goods and services in different countries. This particular basket holds a McDonald's Big Mac, whose price around the world we compared with its American average of $4.20.

According to burgernomics the Swiss franc is a meaty 62% overvalued. The exchange rate that would equalise the price of a Swiss Big Mac with an American one is SFr1.55 to the dollar; the actual exchange rate is only 0.96. The cheapest burger is found in India, costing just $1.62. Though because Big Macs are not sold in India, we take the price of a Maharaja Mac, which is made with chicken instead of beef.

The euro, which recently fell to a 16-month low against the dollar, is now trading at less than €1.30 to the greenback. The last time we served up our index in July 2011, the euro was 21% overvalued against the dollar, but it is now just 6% overvalued. Other European currencies have also weakened against the dollar since our previous index, notably the Hungarian forint and Czech koruna, which have fallen by 23% and 16% respectively. Six months ago both currencies were close to fair value, but they are now undervalued by 37% and 18%.