Introduction

In Economics, numerous factors, policies, or issues will affect a supply of a product

or service to either decline or increase. This is especially evident in microeconomics
where the Law of Demand states that,

“When other things are equal (ceteris paribus), the quantity demanded of a
good falls when the price of the good rises.”

What the above statement is trying to say is that microeconomics deals with a
branch of economics that examines the functioning of individual industries and the
behavior of individual decision-making units, that is, business firms and households.

In this paper, I will concentrate more on the impact of certain issues on households
as it is easily more relatable to the readers of this paper for easier understanding. I
will try to critically examine the impact of decline and increase in household income
on the sale of new passenger vehicles in the United States of America.

The current issue I have chosen is the “2007 US Economic Recession” and how its
impact on Household Income has significantly decreased purchases of new
passenger vehicles and afterwards, I will also briefly mention the steps that were
taken by the American Government to counter this decline via its “Cash for Clunkers”
Program.
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The 2007 American Recession

The financial crisis of 2007 has been called the worst financial crisis since the
American Great Depression by leading economists (Dean barker, 2009), and it
contributed to the failure of key businesses, declines in consumer wealth i.e. income
estimated in the trillions of U.S. dollars, substantial financial commitments incurred
by the government, and a significant decline in American economic activity. Many
causes have been proposed, with varying reasons given by experts. Both market
based and regulatory solutions have been implemented or are under consideration,
while significant risks remain for the world economy due to America’s nature as a
leading Economic superpower.

Due to the direct relationships between declines in wealth, and declines in

consumption, Americans had to reduce their spending as threats to their job security
and future income increased. The American unemployment rate jumped to 9.5%, an
increase of twice the percentage before the recession. With the American population
at 250 million, there are 23.7 million individuals unemployed. To put that into
perspective, that is more than the ENTIRE population of Malaysia, without work.

This is not the first time America has suffered a recession, below is a chart showing
the years America has suffered a recession.

The number One (1) represents the “good economic years”, and the Zero (0)
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represents the years suffered by recession.

What is Income?

Income is the consumption and savings opportunity gained by an individual or

business within a specified time frame, which is generally expressed in monetary
terms (N. Barr, 2004). However, for households and individuals, "income is the sum
of all the wages, salaries, profits, interests’ payments, rents and other forms of
earnings received in a given period of time” (Case & Fair, 2007).

Hence, income is tied directly to an individual’s ‘earning power’, without work or

employment; expenditure will drop due to a lower ‘spending power’ as more and
more people will opt to save whatever assets they may have to weather out the
storm of this economic recession.

Below is a chart of the median income earned by Americans from 1967 till 2008 as
well as a table giving the individual years’ median income on the following page.

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American Household Income
Year Median Income
1970 43,219
1971 42,798
1972 44,632
1973 45,533
1974 44,091
1975 42,936
1976 43,649
1977 43,925
1978 45,625
1979 45,498
1980 44,059
1981 43,328
1982 43,212
1983 42,910
1984 44,242
1985 45,069
1986 46,665
1987 47,251
1988 47,614
1989 48,463
1990 47,818
1991 46,445
1992 46,063
1993 45,839
1994 46,351
1995 47,803
1996 48,499
1997 49,497
1998 51,295
1999 52,587
2000 52,500
2001 51,356
2002 50,756
2003 50,711
2004 50,535
2005 51,093
2006 51,473
2007 52,163
2008 50,303
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Comparison: Economy and Median Income

As can be seen above, the peaks and valleys of the Median Income, corresponds to
the Economic health chart above it. This proves that during times of recession, the
Median Household Income in America does suffer from decline. Due to the economic
conditions, the spending activities of consumers will also be affected with declines in
new purchases due to the uncertainty of future earnings prospects.
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How the Recession has Changed Consumer Spending Behaviours

The impact of the recession has had on American consumers and how it’s changed
their behaviour as a society will be with the Americans for a very long time.

As can be seen in the table below, the expenditure on goods has declined by 3.2%
from 2007 till 2009 with spending in vehicle related matters declining by 1.1% less
for new vehicle purchases and 1.3% less spending on gasoline. With the recession,
the industry hit the hardest would be the automobile related industries.

These days most consumers aren’t willing to spend without significant sales
incentives, such as the “Clash for Clunkers” program. Spending in all categories,
especially luxury goods is down and based on the table above, due to the
uncertainty in the future, most consumers are saving more.
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Consumer Spending: New Car Purchases during Recessions

As can be seen in the charts above, you will notice a trend in that during each of the
years hit by the recession, due to the decline in income per household and its effect
on spending, new car purchases has also seen a sharp drop, and what is most
interesting is that aside from an increase in the years 2000 and 2001, the new car
purchases numbers has continuously dropped to below the 1970’s numbers. This is
in direct contrast to the increase of the household median income, as can be seen in
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the second chart, the reasons for this although interesting will not be touched upon in
this paper.
Consumer Spending: Spurring Consumers to Spend

The American Government, in an effort to save the American Auto industry has
introduced a program to spur new car purchases, this program called the Car
Allowance Rebate System (CARS), colloquially known as "Cash for Clunkers", was a
US$3 billion U.S. federal scrappage program intended to provide economic
incentives to U.S. residents to purchase a new, more fuel efficient vehicle when
trading in a less fuel efficient vehicle. The program was promoted as providing
stimulus to the economy by boosting auto sales, while putting safer, cleaner and
more fuel-efficient vehicles on the roadways.

Some economists have argued that the “Cash for Clunkers” program is the kind of
economic policy required to avoid the liquidity trap in times of economic depression,
they state that:

“The boost in demand that the rebates have brought about is exactly the sort of
stimulus that is urgently needed to escape what John Maynard Keynes called a
“liquidity trap”. According to his theory, consumers may become so worried about
the economy that they cling to as much liquid wealth as possible, cutting their
spending sharply and thereby triggering precisely the slump they feared. Moreover,
as stimulus policies go, cash-for-clunkers looks to be unusually effective. Admittedly,
that is not an especially demanding measure, given that Keynes (John Maynard
Keynes) favoured, if need be, burying money in bottles for people to dig up and
spend. Cash-for-clunkers has many benefits beyond simply getting more money
passing through the hands of consumers and into aggregate demand.” (The
Economist, 2009)

Take for instance, if a Honda City cost USD20,000, if you provide a rebate for
USD4,000. The price of the car would drop considerably to USD16,000. This is a
huge incentive for individuals thinking of buying a new car during the recession. A
graphical representation can be seen in the next page.
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Conclusion

In conclusion, it has clearly been shown that due to the recession experienced by
America, the Median Household Income for American families has also dropped.
This trend is seen through the years that during times of financial difficulties, the
income earned by an individual will decline, this in turn will change the consumer’s
spending habit from a “spend all” mentality to a “Save all” way of thinking. With more
and more consumers, saving more and spending less, a ‘liquidity trap’ may appear
and further increase the economic recession. As an example, new car purchases
have declined remarkably, further endangering the American Automobile
manufacturers already suffering from the recession.

Due to that cause, the American government has spent USD 3 Billion to stimulate
the economy by offering new car purchases’ rebates on car prices. What impact this
may give to the recession will not be known until next year, 2010, when the exact
data on its given benefit to the American economy will be known.
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Bibliography

1. Barr, N. (2004). Problems and definition of measurement. In Economics of the

welfare state. New York: Oxford University Press. pp. 121-124

2. Case, K. & Fair, R. (2007). Principles of Economics. Upper Saddle River, NJ:
Pearson Education. p. 54

Emerling, Suzi (2009). Less Spending on Gas and Cars Means More Money in the
Bank—For Now. Center for American Progress. Retrieved 3rd of November
2009, http://www.americanprogress.com

How the Recession Has Changed Consumer Behaviour, retrieved 4 th of November

2009, http://www.techcublog.com

Retail New Passenger Car Sales, retrieved 4th of November 2009,

http://www.rita.dot.gov

Car Allowance Rebate System, retrieved 4th of November 2009,

http://ww.wikipedia.org

Income, retrieved 4th of November 2009, http://www.wikipedia.org

Income, Poverty, and Health Insurance Coverage in the United States: 2008,
Carmen DeNavas-Walt, Bernadette D. Proctor, Jessica C. Smith, retrieved 1 st
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