Endogenous Consumption, Consumer Behavior And Consumption Growth

As the Permanent Income/Life Cycle theory stemmed from explaining the "Kuznets Puzzle", their theoretical premise is that the average propensity to consume (APC) is unchanged in long-term. But the biggest problem of our country is that the APC has been decreasing. Therefore the assumption of neoclassical consumption theory does not be adequate for our country. The purpose of this paper is to establish a consumption function to analyze the consumer behavior of different income levels, through the introduction of loss aversion behavior, and interpret the declining of APC from consumer behavior. We give some suggestions for increasing the endogenous consumption of Chinese residents. This paper is composed by three parts.First, we analyze the relationship between endogenous consumption and consumer behavior through the definition of endogenous consumption, and then review the neoclassical theory about endogenous consumption. Endogenous investment and consumption play an important role in achieving endogenous growth of our economy. The so-called endogenous consumption means that in the existing economic system, consumption depends only on the spontaneous participation residents are willing and able to consume, while not depends on external stimulation. The increased consumption results from the change of consumption patterns, and the direct reflection of the increase is the changes of the average propensity to consume which is composed by the spontaneous consumption and the marginal propensity to consume two parts. The problem United States and other Western countries mainly face is insufficient savings, and in Permanent Income/Life cycle theory, the permanent income is defined as a lifetime annuity value of wealth, and the condition consumers maximize utility is current consumption equals permanent income. Since permanent income of marginal propensity to consume is 1, we lose the theoretical basis for the further research on marginal propensity to consume. Mainstream consumer theory assume consumers are homogeneous in the study, which completely ignores the behavioral diversity among different income levels, but also fails to consider effects different types of expenditure and income have on consumer decision-making behavior. Because there are factors affecting marginal propensity to consume in the long run, the marginal propensity to consume using time-series data is average for the period of time, while is estimated accurately with cross-section data.Second, we introduce prospect theory of behavioral economics to analysis the effect that loss aversion has on consumer behavior. Combined with Deaton and others'research on the piecewise linear consumption function, we establish a consumption function with the features of loss aversion. Prospect theory tells us that the value people feel is not the final state but its changes of wealth or welfare. The function is convex for loss and concave for gain, and, in addition the region of loss is steeper than the area of gain, which is loss aversion. After a brief introduction of prospect theory, we recall the behavior consumption theory about endogenous consumption. Behavioral life cycle theory rediscusses issue of the marginal propensity to consume, and finds that the marginal propensity to consume is different for different mental accounts, and the money within different mental accounts can not be freely converted. Consumers achieve self-control by pre-setting mechanism in which a part of money will be put into a account with low propensity to consume. Bowman et al give a consumption function including loss aversion, prove that consumer behavior is two stages under the framework of the optimal analysis, analyze effects that reference point has on consumer behavior, and, hence different types of expenditure lead to different consumption behavior. Thaler also pointed out in psychological account that consumption will be classified into different expenditure budget, so as to achieve self-control mechanism to balance the competition among various types of expenditures. Based on this, we establish a piecewise linear consumption function with loss aversion, and test it using the household survey in Shandong Province and national data. The conclusion is the datas support our point. In the consumer decision-making, expenditures ensuring a minimum standard of living are separated and taken into a separate account. Generally, consumers will not lower their living standards.Third, we use piecewise linear consumption function to analyze consumer behavior of resident, and demonstrate the factors impacting reference point and the marginal propensity to consume. In the piecewise linear consumption function, the marginal propensity to consume is 1 when income is below the reference point, while the marginal propensity to consume is far less than 1 when income exceeds reference point. So it is effective to give subsidies to those residents below the reference point for expanding consumer needs. After analyzing the loss aversion of consumer behavior of urban residents, we find the factors that lead to lower future living standards, such as increased expenditure or reduced income in the future, will change consumer behavior. The marginal propensity to consume of urban residents falling by 25 percentage is almost linear downward trend from 1988 to 1998. From the view of institutional change process, China conducts rapid market-oriented reforms after 1992, the reform of health, education, housing, employment and pensions launched progressively, except increased income, and the traditiongal social security system disintegrated. As a result of society changes and the absence of social security causing psychological impact, household savings substantial increase, which is the main reason for the marginal propensity to consume. Based on empirical study with time-series data, we find both reference point and the future risk will negatively affect the marginal propensity to consume. The expenditures in housing, medical care and education affect significantly the reference point, especially the first factor. Therefore, it should introduce monopoly tax, by which revenue can be shifted from the corporate sector to the social security system, meanwhile it can narrow the income gap as well as expand consumption.