Theory of Consumer Choice and Frontiers of Microeconomics
Week 5 exposes students to subjects that are intended to whet their appetites for further study in economics. Students will use the theory of consumer choice and the impact of the concepts of asymmetric information, political economy, and behavior economics, to describe how consumers make economic decisions.
Scenario: You have been asked to assist your organization’s marketing department to better understand how consumers make economic decisions.
Write and present a 1,050-word analysis including the following:
The impact the theory of consumer choice has on:
Higher interest rates
The role asymmetric information has in many economic transactions.
The Condorcet Paradox and Arrow’s Impossibility Theorem in the political economy.
People are not rational in behavior economics.
Cite a minimum of three peer-reviewed sources not including your textbook.
Format consistent with APA guidelines.
Theory of Consumer Choice and Frontiers of Microeconomics
Consumer choice can be defined as the decisions that a consumer makes regarding products and services. The study of consumer choice behavior is, therefore, an examination of how consumers decide on which type products to purchase or consume over time.
Individual decision-making is the cornerstone of nearly all of microeconomic analysis. In the conventional view, rational choice is taken to mean the process of ascertaining and assessing the available options and then choosing the most attractive prospect according to some pre-established criterion (Marshall, 2014). In some respect, this rational decision model is seen as an optimization-based approach. Some of the questions asked in this area of study include; what precipitates and guides these individual consumer preferences? Why do customers purchase some commodities while ignoring others? How do they arrive on what quantities to buy of each product? What is the purpose rational income spending for a consumer?
The utility maximization approach came to be as a result of a remarkable intellectual convergence during the 19th century. From one end, utilitarian philosophers sought an objective criterion for the science of government. Since the school of thought favored policies that were e decided based on getting the “the best possible return from the least expense,” they would need to find utility indices that could predict how effective different policies would be too different people (Foxall, 2005). The others corner featured thinkers following Adam Smith. They sought to refine his ideas on how an economic system centered on individual interests would work. That project, too, could be extrapolated by developing an index of self-interest, analyzing the benefits various outcomes.
For everyday goods and services, demand is depicted with a downward sloping curve, the quantity on the x-axis usually increases as the price on the y-axis diminishes (and vice versa). As implied by the demand curve, the price is the main factor to consider while making a decision to purchase a certain product or service (Marshall, 2014). Another critical factor to consider of product/service pricing is its price elasticity, which intimates how responsive demand is to prices changes. Economists use demand curves to project the effect of a price change on the consumer choices in a market. The order quantity may change as a result of a shift in either demand or the appearance of a new demand curve, as demonstrated in movements on the established demand curve (Buechner, 2013).
The theory of consumer choice has both beneficial and adverse effects on higher wages. If the customer increases the demand of a particular commodity by increasing its utility, it implies the budget will be high and thus lowering wages. If customers reduce the requirements for goods, the high wages will be positively affected because less money will be used to purchase the product. Should the price of this particular commodity rise, consumers will be forced to spend more on the same goods leading reducing the high wages as they will be devoted to the increased expenses (Sen, 2007). A reduction in the prices of the preferred commodities will see the consumers spend fewer fractions of their salaries and thus profound effects on the higher salaries. Should the prices of the related goods increase, consumers will avoid purchasing them, and the higher wages will be not be affected much since the consumers will buy the merchandise at lower prices? Effects of the consumer theory on higher interest rates can manifest themselves both positively and negatively (Buechner, 2013). If the expenditure and consumption are high, interest rates will be high. This is because consumers will spend more on their preferred commodities raising the interest rates. On the other hand, if the expenditure and consumption are low, interest rates will be reduced, since consumers’ purchasing power is low (Foxall, 2005).
If the commodity prices rise in the market, consumers will reduce their consumption and thus the higher interest rates will reduce. If the demand curve dips on the preferred product due to low prices, the consumer purchasing power will rise along with the interest rates. Consumers’ wealth also impacts the interest rates. An increase in wealth and living standards will increase the purchasing power of consumers, thus maintaining high-interest rates. Reduction in consumers’ wealth will result in reduced consumption of their ability to purchase their favorite commodities forcing the lenders to lower their interest rates. Alternate products also influence the interest rates significantly. Increased costs of alternative products will shoo away buyers, necessitating a reduction in interest rates, which in turn reduces prices, consumers will be able to buy more, and thus the market has to increase the interest rates (Sen, 2007).
Asymmetric information, is at times defined as information failure, is a scenario in which one party to an economic transaction has greater information on the product than the other party. This situation typically happens when the seller of good or service has more information on the product than the buyer, although the vice versa is possible (Hansen & Christensen, 2014). Virtually all economic transactions have a form of information asymmetries. If the commodity preferred by the consumers is high on demand, it increases the role that asymmetric information in the economic transaction, since the customers will increase the purchasing power of a well-known product if the product has weak demand because the sellers have little information about the product and vice versa (Marshall, 2014).
The Consumer Choice theory affects the Condorcet Paradox and Arrow’s Impossibility Theorem in the political economy. All consumers have their preferred commodity in a market with no unique goods or services (Hansen & Christensen, 2014). In the political economy, though there must be a more preferred product it may not be consumed uniformly, leading to a situation whereby there is a conflict. For instance, if there are three candidates to be voted in, and one is chosen, arguments may arise in which the voters want their man to win thus leading to a cyclic situation. If the theory of consumer choice is put into use, the cyclic situation will not exist since there will always be a clearly preferred candidate.
Arrow’s Impossibility Theorem states that; every individual has an order of preferences, with no dictatorship. Scientists argue that in the political economy consumers will go for the product or a person depending on how that product is important to them. They will choose a person whom they think can satisfy their needs most and ignore the alternative. For instance, if two contestants are running for a post, voters will prefer one who has the qualities of their choice, naturally (Hansen & Christensen, 2014).
Consumers in the market are always seen as rational thinkers when they are making decisions. This theory may have both true and false. Irrational people in behavior economics may be influenced to choose a commodity which satisfies them. They may be forced to make a rational decision of a given product.
Marshall, A. (2014). Principles of Economics (1st ed.). New York: Palgrave Macmillan.
Sen, A. (2007). Microeconomics (1st ed., pp. 2,15,33). New Delhi: Oxford University Press.
Hansen, F. & Christensen, S. (2014). Emotions, Advertising and Consumer Choice (1st ed.). Frederiksberg: Copenhagen Business School Press.
Foxall, G. (2005). Understanding Consumer Choice (1st ed., p. 22). London, UK: Palgrave Macmillan UK.
Buechner, N. (2013). The Theory of Consumer Choice I | Objective Economics. Objectiveeconomics.net. Retrieved 3 March 2017, from http://objectiveeconomics.net/2013/07/the-theory-of-consumer-choice-i/