Economic Activity begins when the factors of production, i. e. land, labor, capital and entrepreneurship or organization, get together to manufacture or offer a product to customers. Rent on land, wages for labor, interest on capital and profits for entrepreneurship are the payments made for producing a given good or service. These payments are made to people or individuals who are the potential consumers. The level of economic activity or the level of production and supply of a good or service is solely dependent on the demand for the product and the purchasing power of the consumers.
If the price of any factor in the resource market changes, the entire cycle gets influenced- for example, if the price of capital (which is the interest rate) goes up, it impacts the cost of production of the good or service, which also goes up; profit margins for the entrepreneur decrease because of increased interest payment to the financier. As a result, salaries of the workers decline and may not grow at an increasing rate, or may grow slower than the rate of inflation, which ultimately impacts demand for products and services.
On the product market side, a downturn in the housing market has a negative impact on all products and services which are inputs to the construction business- builders and architects, bankers and financing companies, cement manufacturers, iron and steel companies, glass, ceramic and tile makers, masons and laborers, to name a few. All the people or resources which work for these inputs suffer a decline in demand, therefore decline in profit margins, therefore decline in salaries and therefore decline in purchasing power.
The decline comes full circle to purchase of houses which are expensive and are purchased after all the basic necessities are afforded by the consumer’s salary. Part 2. Changes in consumer behavior, resulting from a reduction in income. Positive change in incomes results in upgrading to a better lifestyle, luxury items, high mass consumption goods. Negative change in incomes leads to substitution for a cheaper option in normal goods, to a point.
However, although inferior or basic goods become expensive when real income declines, consumers tend to buy more of them- this is known as the ‘Giffen Paradox’, as explained by Mason. (Mason, Roger, S. 1989). As seen and observed in the article on Spam, the changes in consumer behavior due to a decline in income reflect a preference for cheaper substitutes, e. g. Spam is a cheaper option when compared to fresh meat cuts, without compromising on nutrition and variety.
Wage earners also tend to avoid going to the supermarket and defer buying decisions, as indicated in the argument for buying Spam, a canned product with longer shelf life. The article on motor homes highlights the postponement of a consumer’s decision to purchase entertainment or pleasure equipment, when salaries decline. It indicates a cut down in purchase of Recreational Vehicles or motor homes which is not really a necessity, due to high costs of financing, escalating gasoline costs, and increasing product costs which is commensurate with the increase in input costs for the RV industry.
However, the article is firm in its opinion that over time, with the easing of interest rates and all round reduction in the price index, the demand for RVs will pick up again in the USA. Part 3. Interaction of Supply and Demand Decrease in economic activity often takes a vicious spiral route and tends to drag down the economy further. The flow of money continues to fall to lower levels, and rate of growth goes down further. If this situation comes up, the market for Spam will also decline, but will still register positive growth, despite rise in its prices.
Food is a necessity and the consumers need to be on subsistence level. In fact, the market demand for inferior goods like bread, rice, potatoes, and staple consumption items will also rise. But conspicuous consumption items like clothing, linen, white goods, kitchenware, lifestyle gadgets, will decline at a faster rate than Spam or inferior goods which offer cheap nutrition and variety within means. With regard to the price of motor homes, we have already read that the dealers are willing to sell at prices prevalent a year ago- so they agree that the people have little or no money to buy.
If salaries decline further, the industry category may go through recession phase, which means that production levels will be cut down considerably, production may stop for a short duration. The supply – demand equation will prevent a dramatic fall in prices, but a 15-20% fall seems possible. The quantities sold will naturally decrease since there will be lesser liquidity in the hands of the people, and they will be prudent buyers, opting for the mid range vehicles, offering value for money.
However, if the finance companies and banks decide to make interest rates affordable at current income levels, then there is a possibility of sales picking up, even though salaries may still be low. Reduction in the price of gasoline will spur sales further, since the cost of living will come down.
Mason, Roger, S. Robert Giffen and the Giffen Paradox (Hardcover) Published by Rowman & Littlefield Publishers, Inc. USA. May 1989. Spam sales rise as consumers trim spending. Much-maligned canned meat benefits from ad campaign, weak economy. The Associated Press. May. 28, 2008 URL: http://www. msnbc. msn. com