2.1. Consumption and Expenditure Theories
Diverse economists such as
Keynes (
1936),
Duesenberry (
1949) and
Friedman (
1957) were interested in studying household consumption expenditure as one of the key factors that determine a country’s wellbeing. From Keynesian consumption expenditure to nowadays, several theories of consumption expenditure’s behaviour have been developed (
Supriya 2015). These theories include the Consumption Expenditure Theory proposed by Duesenberry in 1949. This theory suggests that the consumption expenditure level does not depend on absolute income but rather on an individual’s income. The theory is sometimes alluded to as the relative income theory of consumption expenditure (
Ahuja 2013).
Another theory of consumption expenditure was proposed by Modigliani and is referred to as the “Life Cycle Theory of Consumption Expenditure”. This theory advocates that the profile of consumption expenditure planned by individuals depends on their lifetime income expectations rather than current disposable income (
Gali 1994). Adding to the Modigliani theory of consumption expenditure, Friedman introduced the Theory of Consumer Behaviour. The latter theory is also known as the Permanent Income Hypothesis suggesting that individuals’ consumption expenditure does not depend on their present income rather on their permanent income (
Supriya 2015). For a better understanding, each of the aforementioned theories is discussed in the subsequent paragraphs.
The Keynesian Absolute Income Hypothesis refers to the social consumption expenditure and is determined by copious factors, be they objective or subjective. Nonetheless, all these factors consider the current level of income as the core determinant of total consumption expenditure (
Ezeji and Ajudua 2015). In other words, the Keynesian theory of consumption expenditure asserts that the absolute level of income determines individual and societal consumption expenditure. Consequently, the theory is recognised as the Absolute Income Theory (
Alimi 2013). This theory is also linked to the Keynesian psychological law of consumption expenditure stressing that, though at a different pace, a rise in income level results in consumption expenditure growth (
Jhingan 2002).
In support of the Keynesian theory, the Relative Income Theory of consumption expenditure argues that an individual’s consumption expenditure depends on personal income and its relation to social income. Consequently, if personal absolute income increases while other individuals within the same society do not increase their income with the same percentage, irrespective of his absolute income growth, the individual’s consumption expenditure will remain constant (
Ohale and Onyama 2002;
Supriya 2015). This implies that the variability of individuals’ propensity to consume depends on relative income rather than absolute income. Demonstration and ratchet effects are the twin effects that result from absolute income. The demonstration effect postulates that the households’ individual consumption expenditure levels may be influenced by the consumption expenditure levels of their families and/or neighbours from the same community (
Ohale and Onyama 2002). Conversely, the ratchet effect hypothesises that irrespective of economic situation and decline of income levels, individuals tend to uphold their consumption expenditure level. Further, the ratchet effect posits that during difficult times involving a reduction in income, individuals decide to spend or/and borrow to maintain their consumption expenditure level (
Supriya 2015). Following these arguments regarding the Income Theory of Consumption expenditure, one can conclude that, according to this theory, there is no irrefutable relationship between consumption expenditure and income.
In 1954, Modigliani and Brumberg suggested another consumption expenditure theory known as the Life Cycle Theory of Consumption expenditure. This theory argues that an individual’s consumption expenditure does not depend on their current income but rather on their lifetime expected income (
Gali 1994). Thus, if a person expects to acquire high income in his/her entire life, his/her consumption expenditure level will increase, whilst the consumption expenditure will remain at a low level for a person expecting a modest lifetime income (
Deaton 2005). A good example is when a young person inherits his/her parent’s wealth. In the beginning, this person expects the income level to remain high; however, as time goes by the reality proves otherwise. Consequently, even when he/she starts working, the level of consumption expenditure diminishes as one portion of income is served for future consumption expenditure. The situation changes at the period of retirement when consumption expenditure increases due to the wealth accumulated during his/her lifetime through savings and/or investment (
Gali 1994). Nonetheless, this theory assumes that the person under consideration does not inherit anything from his family yet consumes only his accumulated wealth within the economy where the interest rate and price levels are constant (
Ochechuku 1998). Although
Deaton (
2005) states that the Life Cycle Theory of Consumption expenditure remains relevant, the theory’s drawback is manifested in its inelasticity where it ignores the human limitations concerning future emergencies and uncertainties (
Supriya 2015). Henceforth, there may exist an inverse relationship between income and consumption expenditure, as individuals save for future consumption expenditure.
In line with the Life Cycle Theory of Consumption expenditure, in 1959 Milton Friedman introduced another theory known as the Permanent Income Theory of Consumption expenditure. The theory also supports the current consumption expenditure and depends on income expected in the long term (
Supriya 2015).
Friedman (
1957) argues that people make decisions on current consumption expenditure based on the income they expect to acquire through wages and return on their investments. Contrary to the Life Cycle Theory of Consumption expenditure, the Permanent Income Theory of Consumption expenditure acknowledges factors that affect wealth accumulation such as exchange rate and interest rates that may also impact on consumption expenditure levels (
Supriya 2015).
2.2. Empirical Evidence on the Linkage between Petrol Price, Disposable Income, Exchange Rate and Consumption Expenditure
Since factors that affect income and wealth accumulation may impede on consumption expenditure, the next section represents some of the empirical evidence of various factors such as exchange rate and petrol price that influence consumption expenditure.
The exchange rate is one of the macroeconomic variables that may have a significant impact on household consumption expenditure. As illustrated by
Ezeji and Ajudua (
2015), the exchange rate refers to the value of one currency expressed in terms of other currencies. Thus, when the domestic currency loses its value or rather depreciates, it becomes difficult for domestic consumers to acquire either foreign currencies or goods and services from abroad. Conversely, when the domestic currency appreciates foreign currencies, goods and services become less expensive for domestic consumers. In simple terms, domestic currency depreciation enhances domestic purchasing power (imports become less expensive) whilst their depreciation weakens domestic purchasing power (expensive imports and inexpensive exports). This implies that household consumption expenditure and exchange rate are closely linked (
Choi and Devereux 2006). In the United States of America, the validity of this linkage between the aforementioned macroeconomic variables (consumption expenditure and exchange rate) was practically prevalent through a decline of the US dollar for the period ranging between 2000 and 2008 (
Heim 2010). During this period, imports become expensive for American consumers. Nonetheless, within the same period, the country (the USA) increased its exports as they were inexpensive within the global markets (
Heim 2010). The study of
Ezeji and Ajudua (
2015) also revealed a positive relationship between consumption expenditure and exchange rate in Nigeria. Appreciation of Nigerian currency (naira) led to high consumption expenditure, while its depreciation caused a decline in consumption expenditure levels. The study of
Bahmani-Oskooee et al. (
2015) indicated that exchange rate fluctuation results in high inflation, which causes a decline in consumer purchasing power. In support of these findings, the study of
Muzindutsi and Thandiwe (
2018) confirmed that South African households increase their consumption level as results of Rand appreciation. Thus, an inverse relationship exists between the exchange rate and consumption expenditure. Irrespective of these findings suggesting that currency appreciation and high consumption expenditure level are associated, some other empirical findings (
Opazo 2006;
Benigno and Thoenissen 2008;
Corsetti et al. 2008) attested that consumption expenditure increases when the domestic currency depreciates. Grounded on these findings dichotomy, it can be concluded that the linkage between consumption expenditure level and the exchange rate depends on the country’s economic nature and structure.
Irrespective of the high improvement growth of renewable energy sources, fuel energy remains dominant in the energy markets and its shocks affect both countries and individuals’ wellbeing (
Popp et al. 2014). However, the oil effect on the economy may depend on whether a country is an oil producer (exporter) or oil importer. The petrol price depends also on economic structures and monetary policies adopted by the country (
Wang 2013).
A high oil price may lead to high national income and economic growth, thus increasing consumption expenditure, while a high oil price may lead to the high cost of production and thus increase prices for production and reduces consumption expenditure (
Ghalayini 2011). In other words, other things being constant, an increase in fuel price generates GDP growth for fuel producer countries while a large portion is spent on the purchase of fuel products for fuel importing countries (
Aucott and Hall 2014).
Petrol price has a significant impact on household consumption expenditure. The study of
Valadkhani and Mitchell (
2002),
Kinni (
2006) and
Rangasamy (
2017) found that an increase in petrol price impacts on household and personal consumption expenditure through inflationary growth. An increase in petrol price causes price increases even for non-petrol products. For example, if the cost of transport increases as a result of the petrol price, the cost of production will also increase and, consequently, the selling price for the final products will also follow the same pattern in price growth. Contrary to these findings, the study of
Algaeed (
2017) revealed that oil price shocks generate income to households in Saud Arabia and consequently increase consumption expenditure.
Besides the petrol price and exchange rate, the consumption rate is also influenced by income levels. Studies conducted by
Diacon and Maha (
2015) and
Keho (
2019) in Cote d’Ivoire, and
Lira (
2016) in Lesotho indicated that a low level of income restrains private consumption whilst a high level of income results in high households’ consumption.
Employment is the source of income for most households. Any factor that reduces employment also has a negative effect on household consumption expenditure. That is, if fuel price affects economic growth (GDP), it also affects employment and thus impacts on consumption expenditure. The study conducted by
Alkhateeb et al. (
2017) in Saudi Arabia indicated that a positive relationship exists between oil price and employment rate. These results make sense as the country is a producer and exporter of oil. An increase in oil price leads to an increase in both exports and GDP and thus to labour demand. Contrary to
Alkhateeb et al.’s (
2017) findings, the study
Sköld (
2020) conducted on the economies of Sweden, Norway, Denmark and Finland showed that an increase in oil prices causes unemployment growth and decline of employment. In support of these contradictory results, the study of
Kisswani and Kisswani (
2019) in the United States revealed the existence of an asymmetric relationship between oil price and employment levels. Based on these reviewed empirical studies, one can conclude that the effect of petrol (oil) price on employment differs from country to country depending on whether the country is a producer or a consumer of oil products. This conclusion is in line with the finding of
Negi (
2015) in his study on the effect of oil price on countries’ GDP; he found that increase in oil price positively correlated with GDP and employment in Russia and Brazil with negative effects on GDP in China and India.