Why is investment spending more sensitive than consumption? 

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pohnpei397 eNotes educator | Certified Educator

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Investment spending is more sensitive to changes in things like income and consumer confidence because it is much more of an optional thing than consumption.

Much consumption (but not all) is necessary and cannot really be put off.  A family must pay its rent or its mortgage so that it continues to have lodging.  It must continue to buy food.  It must continue to buy school supplies for its children.  All of these expenses and more are not truly optional.  Therefore, even when the family’s income drops, consumption does not drop drastically.

By contrast, investment is completely optional.  Of course, it is very important to save for retirement.  However, if a family fails to invest in the short term it does not typically see any of the consequences of that failure.  Failing to pay into an IRA does have consequences, but they are much less immediate than failing to pay the rent.

Therefore, the incentive to consume is much higher than the incentive to invest and consumption is less affected by changes in such things as income.

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thanatassa eNotes educator | Certified Educator

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The key difference between investment and consumption spending is that much of consumption spending is obligatory, while investment is discretionary.

Imagine a middle-class suburban family. Their consumption spending might include a mortgage, a car payment, gasoline, groceries, insurance, medical care, internet, and cell phones. In times of scarcity, they might be able to reduce the costs of some of these items, but most are fixed and unavoidable. The same family, though, in times of high inflation or financial stress, might reduce contributions to pension or savings plans in order to be able to afford basic necessities.

Investment spending is dominated by larger entities, such as businesses, pension funds, and mutual funds, and is more sensitive to things like interest rates and other large-scale economic factors. Investors can choose to hold cash rather than invest it, at time of low interest rates.

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