How is Inflation affecting Consumer Behaviour?

Prices for almost everything are rising, forcing millions of Americans to make increasingly difficult decisions.

 

According to a new report from market research firm The NPD Group, more than 8 in 10 consumers plan to reconsider or even reduce their product spending in the next three to six months.

 

"There's a tug of war between the consumer's desire to buy what they want and the need to make concessions because higher prices are hitting their wallets," said Marshal Cohen, NPD's chief retail industry advisor.

 

What is Inflation? 

 

Inflation is defined as a rise in prices that results in a loss of purchasing power over time. The average price increase of a basket of selected goods and services over time can reflect the rate at which purchasing power declines. The increase in prices, which is often expressed as a percentage, means that a unit of currency buys less than it did previously. Inflation is distinguished from deflation, which occurs when prices fall while purchasing power rises.

 

While individual product price changes are easy to track over time, human needs extend beyond just one or two products. Individuals require a wide range of products and services in order to live a comfortable life. Commodities such as food grains, metals, and fuel, utilities such as electricity and transportation, and services such as health care, entertainment, and labor are examples.

 

Inflation seeks to assess the overall impact of price changes on a wide range of goods and services. It enables a single value representation of an economy's increase in the price level of goods and services over time.

 

Inflation is defined as the eventual loss of a currency's purchasing power. The growth in an economy's average price level of a basket of selected goods and services over time is a quantitative measure of the rate at which purchasing power declines. A rise in the overall level of prices, expressed as a percentage, indicates that a unit of money now buys less than it did previously. Inflation differs from deflation, which occurs when the purchasing power of money rises but prices fall.

 

Also Read | What is Inflation? Demand-pull and Cost-push

 

What causes Inflation? 

 

Inflationary prices can be caused by two different factors: demand-pull inflation and cost-push inflation. Both return to the basic economic principles of supply and demand.

 

Inflation is caused by an increase in the quantity of money, which can occur due to a variety of economic factors. The monetary authorities can increase the money supply by printing and distributing more money to individuals, legally devaluing (decreasing the value of) the legal tender currency, or more commonly (and most commonly) by lending new money into existence as reserve account credits through the banking system by purchasing government bonds on the secondary market from banks.

 

Money loses purchasing power whenever the money supply is increased. Inflation is caused by three processes: demand-pull inflation, cost-push inflation, and built-in inflation.

 

1. Inflation caused by demand:

 

Demand-pull inflation occurs when demand for goods or services increases but supply remains constant, causing prices to rise.

 

There are several causes of demand-pull inflation. People and businesses make more money in a healthy economy. This increased purchasing power enables consumers to purchase more than they could previously, increasing competition for existing goods and raising prices as companies attempt to ramp up production. On a smaller scale, the sudden popularity of certain products can cause demand-pull inflation.

 

For example, at the start of the coronavirus pandemic, the increase in demand for indoor, socially distant activities, combined with the highly anticipated release of Animal Crossing: New Leaf, resulted in a surge in demand for indoor, socially foreign activities. 

 

According to New Horizons, the price of the Nintendo Switch gaming system has nearly doubled in some secondary markets. Because Nintendo was unable to increase production due to factory production halts caused by Covid-19, Nintendo was unable to meet rising consumer demand, resulting in increasingly higher prices.

 

2. The Cost-Pushing Effect:

 

Price increases in manufacturing process inputs cause cost-push inflation. When increases in the supply of money and credit are channeled into a commodity or other asset markets, costs for all types of intermediate products rise, especially when this is accompanied by a negative economic shock to the supply of essential commodities.

 

These advancements raise the final product or service cost, which raises consumer pricing. When the money supply expands, for example, causing a speculative boom in oil prices, the cost of energy for all purposes may rise, contributing to rising consumer prices, which is reflected in various measures of inflation.

 

3. Built-in Inflation:

 

Adaptive expectations, or the belief that current inflation rates will persist in the future, are linked to built-in inflation. Workers and others learn to expect that as the price of goods and services rises, it will continue to rise at a similar rate in the future, requiring higher expenses or salaries to maintain their standard of living. Their higher earnings raise the cost of goods and services, perpetuating the wage-price spiral as one component induces the other and vice versa.

 

Also Read | Benefits of Inflation in the Economy

 

Inflation and Consumer Behaviour:

 

Perceptions and reality can diverge. People's beliefs, I often believe, are psychological rather than logical. That is, our perceptions of inflation are based not on actual changes in market prices, but on changes that catch our attention. When there are numerous news articles about airfares increasing by 30% or gas prices increasing by 50%, it makes an impression.

 

Inflation is around 8.5% on average, but it varies greatly across categories. Economists examine a basket of commodities and their prices a year ago to get a clear picture. The rest of us are really making subjective decisions based on what we know the price of and what we buy frequently.

 

Inflation perceptions are based on changes that catch our attention rather than real increases in market pricing. Price increases have a significant impact on those who listen to them as well as their purchasing habits. In response to inflation, the article predicts a wide range of consumer behavior. People are constantly looking for bargains, which causes them to alter their purchasing habits because different items may be on sale at different times. Typically, this includes gas and groceries.

 

There is a wide range of behavior changes in response to inflation. You look for sales, which changes what you buy because different items may be on sale at different times. Another strategy is to buy store brands instead of name brands. Private-label sales tend to rise in tandem 

 

You can put off purchasing some products. You buy in smaller quantities for others. Others buy in larger quantities because they believe it is cheaper to buy in bulk. In the short run, inflation can actually increase the quantity of your purchase because you're going to Costco or Walmart. People also start shifting their shopping habits, believing that it will be cheaper at More, Reliance Stores, Walmart, Big Bazars, etc. 

 

It's impossible to say that everyone buys less or trades down; it all depends. For example, when people stop eating out at restaurants, they spend more money on food products than they will eat at home. Because I'm not spending Rs500 on fish at a restaurant this week, I can go to the store and buy one of the better fish rather than the cheapest. You notice these fascinating behavioral changes. There is a lot of complication when it is all put together.

 

Inflation and Consumer Spending:

 

There is a direct impact of inflation on consumer spending, to understand in detail let's look at some of the major determinants below:

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Inflation and Consumer Spending 

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1. Food:

 

Food accounts for less than one-seventh of the average consumer's total expenditures, according to the US Bureau of Labor Statistics. This statistic follows Engel's law: as Americans' income rises, the proportion of their income spent on food falls relative to their income. 

 

According to experts, a greater proportion of food expenditures will be spent at home rather than away from home. Inflation rates will also influence where families shop for groceries, hurting higher-priced grocery stores throughout the area. 

 

Furthermore, as consumers seek ways to stretch their spending dollars, expenditures in the food-away-from-home component are expected to shift toward limited-service restaurants rather than full-service restaurants.

 

2. Travel:

 

Travel spending takes into account data from both airlines and hotels. Data show that travel spending as a percentage of total PCE (Personal Consumption Expenditures) falls during recessions. 

 

This is understandable given that travel accounts for a sizable portion of discretionary spending and is extremely sensitive to economic conditions. Consumers canceling vacations to save money or switching to less expensive travel destinations could explain the decline in travel share. It is worth noting that travel shares of total PCE fell sharply after the September 11th attacks in 2001, and again in 2020 as a result of COVID-related travel restrictions.

 

3. Vehicles & Transportation:

 

Recessions tend to benefit auto parts retailers because consumers are more likely to keep their cars for longer periods of time rather than spend extra money on a new car. Data show that the relative importance of new cars drops dramatically during periods of high inflation. 

 

When there is a recession, the ratio of new vehicle expenditures to used vehicle expenditures falls from about 2.6 to 1.6. The recovery period shows that the relative importance of new cars is significantly higher than it was during the recession, but it is still far below its peak level. The relative importance of new and used vehicles fell by about one-quarter during the recession and has only recently recovered.

 

4. Long-Lasting Products:

 

Durable goods are far more affected by the economic cycle. Furniture, appliances, and automobiles are examples of such items. Durable goods spending is an excellent indicator of real GDP growth because they typically have a much higher sticker price and are more likely to be postponed by consumers during times of economic downturn. Between the 2007 boom and the 2011 recession, the relative importance of durables fell by nearly 20%. The decline is primarily due to vehicles, but the relative importance of furniture and appliances has dropped by approximately 25%. All categories are more important in recovery than in a recession, but they are still lower than previously.

 

Conclusion:

 

In conclusion, Data has repeatedly shown that during economic downturns, consumers will cut several small expenses to save money. However, some consumers' behavior will be unaffected by inflation rates. Still, in general, the consumer price index does an excellent job of reflecting the types of adjustments that consumers are expected to make as the economy experiences high inflation.