Prices and Consumer Incomes

     Prices and Consumer Incomes 

     The other economic factor that consumers must consider carefully in making their purchases of goods and services is their own level of income. Most people earn their income from the work they perform, whether as physicians, carpenters, teachers, plumbers, assembly line workers, or clerks in retail stores. Some people also receive income by renting or selling land and other natural resources they own, as profit from a business or entrepreneurial venture, or from interest paid on their savings accounts or other investments.

     We later describe how the prices for those kinds of payments are determined; but the important points here are that: 1) in a market economy, the basic resources used to make the goods and services that satisfy consumer demands are owned by private consumers and households; and 2) the payments, or incomes, that households receive for these productive resources rise and fall — and that fluctuation has a direct influence on the amount consumers are willing to spend for the goods and services they want, and, in turn, on the output levels of the firms which sell those products.

     Consider, for example, a worker who has just retired, and as a result earns only about 60 percent of what she did while she was working. She will cut back on her purchases of many goods and services — especially those that were related to her job, such as transportation to and from work, and work clothes — but may increase spending on a few other kinds of products, such as books and recreational goods that require more leisure time to use, perhaps including travel to see new places and old friends.

     If, as in many countries today, there are rapidly growing numbers of people reaching retirement age, those changing spending patterns will affect the overall market prices and output levels for these products, and for many others which retirees tend to use more than most people, such as health care services. In response, some businesses will decide to make more products and services geared toward the particular interests and concerns of retirees — as long as it is profitable for firms to produce them.

     To summarize: whether consumers are young or old; male or female; rich, poor, or middle class; every dollar, peso, pound, franc, rupee, mark or yen they spend is a signal — a kind of economic vote telling producers what goods and services they want to see produced.

     Consumer spending represents the basic source of demand for products sold in the marketplace, which is half of what determines the market prices for goods and services. The other half is based on decisions businesses make about what to produce and how to produce it. 
 

     Business in a market economy 

     As we have seen, a firm's success in a market economy depends on satisfying customers by producing the products they want, and selling those goods and services at prices that meet the competition they face from other businesses. Doing that requires firms to develop careful answers to one of the most important questions every economic system faces: how can a society produce goods and services most efficiently? In a market economy, that means getting the greatest value of output from the inputs producers use. 

     To Build a Bicycle 

Let's take the case of a firm that is considering the manufacture and sale of bicycles. Before launching such a venture, any entrepreneur or company has to consider a host of factors. First, what is the potential size and nature of consumer demand for a new brand of bicycle? Is there a single, large market for standard model bicycles? Or is the bicvcle market divided in many smaller markets, or niches, for specialized bicycles for children, customized racing bikes or bicycles built for two? A new trend, such as the sudden popularity of so-called mountain bikes that can handle wilderness trails, might also attract new manufacturers who see an opportunity to make a profit. On the other hand, prospective suppliers may simply feel that they have developed innovative manufacturing techniques for a standard bicycle, or possess significantly lower labor costs, so that the company can undersell their rivals in the marketplace and still make a profit.

     Not only are there many kinds of bikes to make, but there are many ways to make these bicycles — from using a highly automated assembly line to stamp out thousands of identical parts and put the bikes together, to using more labor and much less machinery to design and make customized bikes. Once again, the firm making these decisions in a market economy has to consider several different prices that may rise or fall in response to the behavior of people who buy and sell those products.

     For example, the prices the firm has to pav for its inputs will obviously play a major role in determining how much steel, aluminum, labor, machinerv and other materials the firm will use in making its bicycles. If the price of steel rises and the price of aluminum falls, many bicycle firms will look for ways to use more aluminum and less steel. Similarly, if wages for workers rise sharply, firms will have a strong incentive to look for ways to use more machinery, or capital, and less labor. A firm might decide to buy more fork lifts, for example, using fewer workers to move its inventory around the company's warehouses. Or it might use more machines to make routine and repetitive welds on its bikes, and thus hire fewer workers to do welding jobs. (As a consequence, the number of workers in factories producing the welding machinery used by the bicycle manufacturers would increase.)

     Any such venture carries a large element of risk: a new bicycle design may fail to attract customers, or manufacturing costs may be unexpectedly high, pricing the company's bikes out of the market. Companies alone bear this risk of failure — and reap the economic rewards of success if they have planned correctly and their bicycle venture succeeds.