The theory of consumer choice looks at how consumers are able to make choices regarding which commodities to consume or purchase over time. These theory can be viewed as a macroeconomics’ branch that links preferences to consumers’ demand curves and consumption costs. Further, it examines how consumers decide on which commodity to spend their income on subject to their budget and preference constraints. Most if not all Individuals consumes fewer bundles of goods than they desire because their spending is subject to the available disposable income. The budget constraint dictates the volume of consumption bundles that a person can afford at a given time (Hands, 2007). As a result, this paper examines the role of the theory of consumer choice in relation to Demand curves, higher wages and higher interest rates. Finally, the paper explores the role of asymmetric information on the various economic transactions and why economic agents fail to be rational.
Demand Curve
The consumer choice theory explains how people make spending decisions based on their preferences and budgetary constraints. The consumer choices are predicated on some economic circumstances. The particular economic circumstances are important in shaping the consumer choices. Consumer theory explains how the demand curve behaves from the interplay between the economic circumstances and the consumer purchasing power. The individual taste and prices of goods and services influence the demand curve. When the prices of commodities go up, the consumers will tend to purchase less of the commodity. This means there will be a reduced demand. As such the demand curve will shift downwards. However, when the prices of commodities go down, the consumers would prefer to purchase the commodity pushing the demand up. Consequently, the demand curve will shift upwards (Kőszegi, 2014).
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Higher wages
A better way to demonstrate the role of higher wages impacts on the consumer choice theory is through the income consumption curve. The basic concept is that the variation in the levels of will determine different quantities of a long a quantity curve for two kinds of goods as displayed in the curve below (Solomon, 2014). When the wages of the consumers increase, they have more purchasing power. As such they can afford to purchase more quantities of the commodity while lower wages will reduce the purchasing power of consumers leading to the purchase of smaller quantities of that same commodity. However, this may differ across different kinds of goods. For instance, the inferior goods are often less preferable, and this will experience an inverse relationship when wages increase as opposed to normal goods (Solomon, 2014). Also, for complimentary goods, the rise in income will increase their purchase relative to an individual’s wages. And finally, for substitutes the increase in wages will affect the consumption of the goods interchangeably for either or both commodities.
Higher interest rates
Higher interest rates view of consumer theory will lead to increase in savings by consumers due to increased rate of returns. Also, an increase in the interest rates often leads to high rates of inflation, as such, consumers spend more due to the fear of the purchasing power of their currency being eroded. Two aspects are evident in the consumer habit. Those who would wish to get returns would opt to save so as to earn from the interests while those who are skeptical would opt to spend in advance to prevent suffering the impacts of inflation (Agarwal, Chomsisengphet, Liu, & Souleles, 2015).
Asymmetric information
Asymmetric information plays a major role in many transactions, for is an instance in insurance, the property owner is often unsure how the customer will care for the property. As such, if the customer were so careless with their vehicle it would break down more often leading to many claims. Thus the insurer may not accept to ensure a careless customer leading to adverse selection. Therefore, asymmetric information makes insurers offer big discounts for No claim Bonuses enabling the insurer to get reliable information about customers (Roberts, 2015). Asymmetric information, therefore, enables prevention of adverse selection in many transactions.
Consumer theory is in the view that in behavior economics, people are not rational because they sometimes act based on emotional components. In such a case, an individual may purchase a product that makes little economic sense because they are emotionally driven to it. For an investor, they may be driven by emotions to invest in business despite understanding that their model is not good for the market and may lead to failure. Therefore, factors rather than emotions influences the consumer choice in products and services (Iannaccone, 2016).
References
Agarwal, S., Chomsisengphet, S., Liu, C., & Souleles, N. S. (2015). Do consumers choose the right credit contracts? Review of Corporate Finance Studies , cfv003.
Hands, D. W. (2007). Economics, psychology and the history of consumer choice theory . Camb. J. Econ. 34 (4): 633-648.
Iannaccone, L. R. (2016). Rational choice. Rational choice theory and religion: summary and assessment .
Kőszegi, B. (2014). Behavioral contract theory. Journal of Economic Literature , 52 (4), 1075-1118.
Roberts, M. R. (2015). The role of dynamic renegotiation and asymmetric information in financial contracting. Journal of Financial Economics , 116 (1), 61-81.
Solomon, M. R. (2014). Consumer behavior: Buying, having, and being . Engelwood Cliffs, NJ: prentice Hall.
