Based on comments on my last article, there are misconceptions about consumer spending patterns and the effects of price increases. Consider several potential outcomes caused by price increases:
- A consumer can do without. No vacation, no private school, no newspaper, or no medical insurance.
Click to enlarge images.
- A consumer can perform the same task with lower unit consumption. Examples are buying a more fuel-efficient car, or moving closer to where you work.
- Lower the quality of what you buy -- single malt to blended whiskey, steak to hamburger, private car to public transport, change the temperature in your home, big house to little house, Cheesecake Factory to McDonald's.
- Change the item purchased -- switch from fuel oil to natural gas, theater to satellite TV.
- Do it yourself -- haircuts, gardener, home or car repair/maintenance.
- Find a cheaper source of a product or service.
Three specific items with relatively large consumer price increases were healthcare, food, and gasoline. One would expect these price increases would result in generally taking a larger and larger share of the consumer budget. Yet the data says otherwise.
In the graph above, the change in spending pattern was determined by calculating the ratio of the individual elements (healthcare, food, and gasoline) to the total personal consumption expenditure (PCE). All values were normalized to 100 for first-quarter 2007. The price index comes from the BEA PCE price index.
I keep writing, but many miss, that there is no such thing as an average consumer. Each one of us is a different animal with different consumption profiles. The graphs above represent BEA's total of all consumption (Joe Sixpack, the top 0.01%, banksters, the retired, farmers, students, etc.). To believe a consumer stands still for any long period in the face of price changes is ludicrous. Price changes beget consumption changes.
On the other hand, I believe the vast majority of consumers spend much of what they make. This is why many pundits (including me) keep their focus on changes in real income. This was the point of last week's article. The downward trend in real disposable personal income has been broken for at least one month -- both on a real and per capita basis. This is one of the few positive trends currently in play economically.
One other thought emanating from last week's article is the difference between changes in home values and the changes in home equity. The blue line in the graph below shows how owners' equity loss is significantly more than what the home price indices are saying.
As (or if) the housing recovery plays out, the increase in home equity values will be a multiple of the change in home prices. Yes, it will take some time for homeowners to feel (and believe) their home equity is increasing.
For my weekly economic review, click here. Not only does this review have hyperlinks to analysis of the data and news this week, but it also includes my opinion of the ongoing recession calls.