CONSUMER THEORY: CHARACTERISTICS, APPLICATIONS, EXAMPLES - ECONOMY - 2025

The theory of the consumer is a branch of microeconomics that is dedicated to studying how people decide to spend the money, taking into account their preferences and budget constraints. That is, this theory shows how individuals make their consumption decisions according to certain restrictions, such as their income and the prices of products and services.

The models that make up the consumer theory are used to represent the demand patterns that are prospectively observed in an individual buyer. Through this theory it is possible to better understand how people's tastes and incomes influence the demand curve. These options are among the most critical factors shaping the overall economy.

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Consumers can choose between different packages of products and services. Logically, they choose those that provide the greatest benefit or maximize utility, in economic terms.

Consumption and production

The consumer theory is related to demand, just as the producer theory is related to supply.

Consumption differs from production because two different economic agents are involved. In the first case, consumption is done by an individual. In the second case, a producer could make something that he would not consume. Therefore, different motivations and abilities are involved.

The main difference is that the producer theory assumes that sellers are motivated by profit, which can be measured directly.

characteristics

Consumer theory is based on what people like, so it starts with something that cannot be directly measured, but must be inferred.

That is, consumer theory is based on the premise that what people like can be deduced from the choices they make. Deducing what people like from the decisions they make does not rule out mistakes.

However, the starting point is to consider the implications of a theory where consumers do not make mistakes, but instead make decisions that will give them the most satisfaction.

Required items

Working through cases and / or examples, consumer theory usually requires the following elements:

- A complete consumption set C, which is the set of all the package options that the consumer could consume.

- A preference relation over the packages of C, which can be described as an ordinal utility function, which describes the utility that the consumer gets from each package in that set of options.

- A pricing system, which is a function that assigns a price to each package.

- An initial endowment, which is a C package that the consumer initially owns. The consumer can sell all or part of his initial package at the given prices, and can buy another package, also at the given prices.

You have to decide which package to buy to maximize your profit, based on pricing and your budget.

Substitution and income effect

The leading variables used to explain the rate at which a product is purchased are the unit price of that good, the prices of related products, and the consumer's wealth.

The law of demand states that the rate of consumption falls as the price of the product increases, even when the consumer receives monetary compensation for the effect of that higher price.

This is called the substitution effect. As the price of a product increases, consumers will substitute for it by choosing other alternative goods in greater proportion.

If there is no compensation for the price increase, as usual, then the decrease in purchasing power due to the price increase will lead, for most products, to a further decrease in the quantity demanded. This is called the income effect.

Furthermore, as the individual's wealth increases, the demand for most products will increase, increasing the demand curve for all possible prices.

Applications

Indifference curve

It is a graph that shows a combination of two products that give the consumer the same satisfaction and utility, which makes him indifferent to them.

Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and budget constraints.

Recently economists have adopted the principles of indifference curves in the study of welfare economics.

The analysis of a standard indifference curve operates on a simple graph. Each axis represents a type of economic good. Along the curve, the consumer has no preference for any combination of products, because both goods provide the same level of utility to the consumer.

For example, a child may be indifferent between owning two comic books and a toy truck, or four toy trucks and a comic book.

Work-leisure compensation

Consumer theory can be used to analyze a consumer's choice between leisure and work. Leisure is considered one good (often placed on the horizontal axis) and consumption is considered the other good.

As a consumer has a limited amount of time, he must choose between leisure, which does not generate income for consumption, and work, which does generate income for consumption.

The older model of consumer choice theory is applicable with only slight modifications.

The total amount of time an individual has to allocate is known as his "time endowment", and is denoted as T. The amount of time an individual allocates to work (L) and leisure (O) is limited by T, in such a way that: O + L = T.

A person's consumption C is the amount of work time he chooses multiplied by the amount he is paid per hour of work, which is his salary and is denoted s. Therefore, the amount that a person consumes is: C = s * (TO).

When a consumer does not choose leisure time, it follows that O = 0. Therefore, (TO) = T and C = s * T.

Using this compensation model between work and free time, the substitution effect and the income effect can be analyzed from the various changes caused by social benefits, labor taxes or tax credits.

Limitations of the theory

There are many challenges in developing a pragmatic formula that predicts how a consumer will spend their money. For example, people do not always act rationally and are sometimes indifferent to the options available.

The decision has an emotional component that cannot be captured in an economic function. Also, some decisions are particularly difficult to make because the consumer is not familiar with the products.

Therefore, various assumptions are made in consumer theory to facilitate the process. For example, economics can assume that it understands consumer preferences for different packages of products and services, and can decide how much each wants to buy.

It also assumes that there are enough packages of products and services available for the consumer to select the amount they want of each.

Inconsistency

One of the biggest drawbacks of relying too heavily on consumer theory is that consumers rarely apply the same steps in the same way for every purchase of products and services.

This makes it more difficult for marketers to try to stimulate a need or deliver messages that increase the likelihood of a purchase for their brand.

Therefore, most companies have to do more research on their particular market segments and how they approach their brand.

Limited buyer interest

Another major limitation for marketers using consumer theory is that consumers are sometimes much less involved in a purchasing decision.

For example, someone who buys laundry detergent is less involved in the purchase than someone who buys a car, or a washer and dryer.

Therefore, the ability of sellers to affect consumers is limited. Consumers who are less engaged spend less time searching for or viewing information about a purchase.

Examples

Consider a consumer named Carlos, who has $ 200 in his possession. Therefore, this amount is your budget constraint. You must choose how to allocate your money between pizza and video games, these being the product package.

Suppose the cost of video games is $ 50 and that of pizzas is $ 10. Carlos can purchase any combination of video games and pizzas that cost no more than $ 200. You could buy three video games and five pizzas, or four video games, or 20 pizzas. You could also keep the $ 200.

However, how can anyone predict the most likely way Carlos will spend his money? To answer this question, consumer theory can help.

Substitution and income effect

For example, suppose that the income of consumers is $ 15. On the other hand, the cost of apples is $ 1 and the cost of oranges is $ 3.

At these prices, the consumer can buy six apples and three oranges. The moment the cost of the oranges falls to $ 1, the consumer buys eight apples and seven oranges.

Thus, on the demand curve for oranges, the consumer buys three oranges when the value is $ 3 and seven oranges when the value is $ 1.

References

1. James Chen (2019). Consumer Theory. Investopedia. Taken from: investopedia.com.
2. Wikipedia, the free encyclopedia (2019). Consumer choice. Taken from: en.wikipedia.org.
3. Git Hub (2019). Chapter 12 Consumer Theory. Taken from: saylordotorg.github.io.
4. UK Essays (2019). Theories of Consumer Behavior. Taken from: ukessays.com.
5. Caroline Banton (2019). Indifference Curve. Investopedia. Taken from: investopedia.com.
6. Neil Kokemuller (2017). Limitations of Consumer Buying Behavior. Bizfluent. Taken from: bizfluent.com.