Theory of Consumer Choice

  • Uncategorized

6

The theory of consumer choice analyses the relationship betweenconsumer’s decision to purchase a commodity and the budgetaryconstraints. The basic premise of the theory is that individuals makeexpenditure decisions depending on their disposable income and theprices offered in the market. Thus, they try to maximize utilitybased on what they can afford. This means that the limit to which aconsumer can buy is the most important aspect of the theory. Althougha buyer may desire to consume more, he or she is restricted by his orher financial abilities. However, there is a broader application ofthe theory (Mankiw, 2012). For example, it can be used to explain whyan individual will choose between beer and pizza, spending andsaving, or going to work and vacation.

Consumer choice and demand curves

A demand curve illustrates how consumption changes as a result ofprice adjustments. The choices by consumers are determined by thecost to be incurred. As the price increase, they are less willing toacquire the products. This is because buyers are keen to purchasemore if they spend less. The demand curve is generated by determiningthe quantity of goods or services the consumers are willing and ableto buy at a given price. In a typical market, the curve slopesdownwards. However, the choice involves weighing the utilityassociated with purchasing the goods or services as opposed to theoption of not buying. Additionally, some commodities do not have thenormal demand curve, for example, luxury goods (Varian, 2014).

Consumer choice and higher wages

The level of income has a huge impact on consumer choices. This isreferred to as the ‘income effect’. Several economic factors canbe used to predict whether a buyer is likely to purchase a commodityor not. The central consideration is the level of income because anindividual can only buy what he or she can afford. Additionally, apurchasing decision does not have microeconomic impacts if the buyeris unable to pay for the commodity at a given price. An increase inwages has comparable effects on the levels of consumption, since themore a person earns, the more he or she spends (Mark, 2015).Therefore, the income-consumption curve rises steadily. This is basedon the general economic hypothesis that higher salaries increase thedisposable incomes, which affects budgetary constraints positively.This influences the quantity and value of goods and servicesindividuals are willing and able to buy (Varian, 2014).

However, it is important to note that changes in wealth and incomehave different impacts on consumer choices. While income influencesconsumption based on the amount of money available to spend, wealtheffects are based on perceptions. For example, if a person perceivesthat he or she is wealthy due to an appreciation of properties, he orshe is likely to change spending habits. Additionally, the impacts ofhigher wages on consumer choices are dependent on other factors suchas the category of commodities. In normal goods, an increase in wagesresults in more consumption. However, inferior products (real orperceived), will be less preferred by higher earners, and vice-versa.Income levels will also affect complementary products (Varian, 2014).For instance, better paychecks result in increased car ownership,creating a demand for automobile insurance and fuel.

Consumer choice and Higher interest rates

One of the most important decisions consumers make is the part oftheir income they should spend in the short run and how much theyneed to save for the future. Interest rates on savings have a hugeinfluence on the level of individual or household savings. The impactis dependent on both the substitution and income effects. If theinterest rates are high, it means that a person will buy more at alater date compared to today using the same resources. Thisdiscourages spending and promotes savings. Thus, as a result of thesubstitution effect, buyers will choose to save more (Mankiw, 2012).

The income effect will also influence the impacts of higher interestson consumer choices. An increase in earnings moves the individualinto another indifference curve. This is due to changes in the buyingpower. As a result, the person will tend to consume relatively moreand save less, when normal goods are considered. Therefore, higherinterests will have diverse effects on decisions made by buyers. Itwill discourage or encourage saving depending on whether the incomeor substitution effect is stronger (Mankiw, 2012).

Asymmetric information and consumer choices

Asymmetric information refers to a situation in the market where oneof the parties involved, buyer or seller, has more information thanthe other. It results in a lack of equal powers during transactions.It is associated with market failure and awry deals. For example, itpurges the role of market forces and price mechanism. Inadequateinformation about the commodities offered results in wrong consumerchoices. For example, buyers may be unaware of a technical defect ona cheap electronic model that has been introduced by a renownedmanufacturer. Due to the low price and brand name, many consumerswill choose to buy the product. The wrong decisions will be as aresult of asymmetric information (Mankiw, 2012).

The Condorcet Paradox and Arrow`s Impossibility Theorem

The Condorcet Paradox and Arrow`s Impossibility Theorem can be usedto understand the political economies in which markets operate.According to the Condorcet paradox (also known as the votingparadox), ‘collective preferences’ can be cyclic even when the‘individual voters preferences’ are not cyclic. The paradoxoccurs because the wishes of the majority can be divergent. Thus,voting systems do not produce results preferred by all voters(Mankiw, 2012).

The Arrow`s Impossibility Theorem states that where there are threeoptions in a voting system, it is not possible to satisfy theprinciples of “unanimity, transitivity, independence of irrelevantalternatives, and no dictators.” This means that the individualranking preferences cannot be converted into society rankings (Yu,2012). These two theorems have an impact on consumer choices. Theyillustrate that since there are numerous options in the market, it isnot possible for buyers to make selections that are universallycorrect (Mankiw, 2012).

Rationality in behavior economics

A rational behavior in the marketplace results in consumer choicesthat maximize the benefits or utility. The majority of buyers areless likely to make objective preferences. However, economic theoriesassume that all decisions are made intelligently. Rational choicesare based on logical evaluations, rather than emotional responses.Additionally, they do not usually result in the highest returns butoptimizes the utility. Prudent decisions are, in some cases, notpractical because it is impossible to separate perceptive thinkingand emotions in an ordinary consumer. Due to the human nature,emotional and psychological components have impacts on thedecision-making processes (McKinnon, 2013).

References

Mankiw, N. (2012). Principles of economics. Mason, OH:South-Western Cengage Learning.

Mark, A. (2015). Has Consumption Inequality Mirrored IncomeInequality? The American Economic Review, 105(9),2725-2756(32).

McKinnon, A. M. (2013). `Ideology and the Market Metaphor in RationalChoice Theory of Religion: A Rhetorical Critique of “ReligiousEconomies”`. Critical Sociology, 39(4), 529-543.

Varian, H. (2014). Intermediate Microeconomics, 9th Edition.New York: W.W. Norton.

Yu, N. (2012). &quotA one-shot proof of Arrow`s theorem&quot.Economic Theory. 50 (2): 523–525.

Close Menu