- Consumption is the purchase of goods and services for the acquisition of current utility.
- Investment is expenditure on capital goods for the acquisition of future utility. Investment increases the capital stock.
Examples of the difference between consumption and investment
- A householder buys a car so that they can travel around to work and leisure activities. This is consumption
- A firm purchases a van so that it can make its deliveries to consumers.
Impact of consumption and investment
Consumption increases current utility and leads to higher living standards in the short-term. Investment will require less current consumption but can enable higher living standards in the long term.
This shows a trade off for an economy between consumer goods and capital goods. If the economy moves from point A to point B, it gains 190 capital goods, but there is an opportunity cost of 80 less consumer goods. In the short term, there is less consumption, but the increase in capital goods may enable the PPF curve to shift outwards.
Relation to Saving
If savings increase, then consumption will fall. Higher savings enable more investment in the economy.
Difference between Consumption and Transfers
- Consumption Spending on goods and services that are currently produced. It adds to GDP
- Transfer payments occur where no good or service is received in return, e.g. government benefits. Transfer payments do not directly lead to change in GDP. Only, when the transfer payments are later used to purchase goods, then those purchases become consumption
Test yourself
Why is buying insurance consumption?
- Insurance is a service consumed by households
- It provides current protection/peace of mind, not new productive capacity
- Therefore it counts as consumption expenditure in national income accounts
- Though it is worth noting insurance premiums may be saved or invested by the insurer, that happens after the household’s spending decision
Household Classification of consumption vs transfers vs Invesment
- Holidays – Consumption (C) – Leisure service
- Buying a car (personal use) – Consumption (C) – Durable consumption good
- Buying a new house – Investment (I) – Adds to housing stock
- Home extensions / renovations – Investment (I) – Increases capital stock
- Mortgage repayments- Neither – Transfer + interest (no new output)
Firm classification
- Advertising – Consumption (C) – Service used up in current period
- Office rent – Consumption (C) – Current service
- Building a factory – Investment (I) – Increases productive capacity
- Buying delivery vehicles – Investment (I) – Capital goods
Classification of government spending
- Public sector wages – Government consumption (G) – Current services
- State pensions – Neither – Transfer payment
- Interest on debt – Neither – Transfer
- Building roads / rail – Government investment (Gáµ¢) – Capital formation
Related
- Capital consumption – loss of capital equipment to depreciation.
- Consumption function – factors that affect consumption
- Net investment definition – total capital expenditure minus depreciation of assets.
- Factors affecting investment
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