Consumer behavior dependence effects and review analysis

Consumer Behavior - Dependence

Do advertising and sales allow production to drive demand or vice versa? If so, is this a bad thing? According to John Maynard Keynes' absolute income hypothesis, consumption is a non-linear function of income. As income rises, consumption will rise, but not necessarily at the same rate. For Keynes, demand drives supply. Keynes' ideas are generally accepted in economics. However, John Kenneth Galbraith challenges Keynes with the introduction of his Dependence Effect theory which states that wants depend on the process by which they are satisfied; welfare is not necessarily greater at higher levels of production. Under this theory consumers are never satiated because advertising and sales keep stimulating demand. Suppliers focus on manufacturing demand even more so than on manufacturing products. While many believe Galbraith's analysis to be ridiculous, an examination of market structures, advertising expenditures, consumer behavior and the general welfare of the consumer suggest that Galbraith's theory does have merit.

Most firms are monopolistic competitors. There are several competing firms who supply goods, but, unlike perfect competition, they face a downward-sloping demand curve for their differentiated products. The perfect competitor in long-run equilibrium produces at a point where MC - P - ATC. At that point, ATC is at its minimum. On the other hand, a monopolistic competitor produces at the point, MC - MR. Increasing output will lower average cost. Therefore, monopolistic competitors make great efforts to increase their market share and do so by offering differentiated products in contrast to the perfect competitor with identical products that cause buyers to be indifferent to which seller's products they buy. Because monopolistic competitors sell differentiated products and charge prices above marginal costs, firms have a huge incentive to advertise to attract more buyers for their products.

The advertising industry is growing by leaps and bounds. In 2005, spending on advertising reached$144.32 billiin in the United States and $385 billion worldwide. Worlwide advertising spending is projected to exceed half-a-trillion dollars by 2010. Advertising accounted for 2.17% of GDP in the United States in 2005. Firms that sell differentiated goods typically spend between ten and twenty percent of their total revenue on advertising giving support for Galbraith's claim that suppliers are just as focused on creating demand as they are on creating product.

These advertisements are clearly working. Consumers are wracking up major debt to finance their insatiable demands for consumer goods. For the first time in U.S. history, Americans owe more money than they make. Household debt levels have surpassed household income by more than eight percent, reaching an astonishing 108.4% in 2005. The income restraint which is a classical economic model to reflect a limitation to the consumer's choices in the consumption decision appears to no longer be valid because consumers no longer need to be able to afford a product to buy it. Some may argue that consumerism isn't fueling the rampant consumer debt; the real problem is that wages have been stagnant and consumers just can't keep up with the cost of living. But, following Keynes' line of reasoning, consumption should at least be decreasing as incomes are falling, but, instead, consumption is increasing and now accounts for two thirds of our GDP.

Some are beginning to question, just like Galbraith, if creating wants through the market is really leading to greater well-being. In 1989, the average American consumed twice as much as in 1969, while the average worker labored 160 more hours, the equivalent of an extra month of full-time employment. The expectation that productivity increases would eventually translate into greater leisure clearly hasn't materialized.