Theory of Consumer Choice and Frontiers of Microeconomics
The theory of consumer choice belongs to a branch in microeconomics that correlates with the preferences to consumer demand curves and consumption expenditures. The theory analyzes how buyers maximize their consumption desires as per their preferences and budget constraints. It addresses demand curves, effects of wages and interest rates in an attempt to understand how consumers make economic decisions. Consumer theory shows decisions people make given the price of goods and services and their income which helps us understand their tastes and incomes influence on the demand curve.
Demand curves
Demand curves for good or a service reflect the desire and willingness of a consumer to pay for it thus arises from the theory of consumer choice. The demand curve reflects a consumer’s decision for a particular good at any given price. The demand curve slopes downward when the price for a good rises to reflect a reduced demand for the good which is the law of demand which states that the consumption cascades as the price of good increases. A consumer will move to other alternatives which have relatively low prices than the other good. Alternatively, the demand curve increases when the price of a good decrease is indicating that the consumption of the good has gone up as well as the demand curves. The decrease or increase in consumption of an item implies the Theory of Consumer Choice and its principles. However, there are rare occasions where the consumer purchases less even with a reduction in the price of an item, a rare property of consumption associated with Giffen goods.
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Higher wages
The theory of consumer choice has both negative and positive impacts on higher wages. When people receive higher wages, they are driven to increase their consumption rates as their budget constraints are steeper which directly have an impact on the relative price. Disposable income increases the demand curves as they generate a higher return to the local economies. An individual with an increased wage is propelled to spend more on goods or their purchase for luxury goods increases. An increase in consumption drives up the demand curve which creates a greater equilibrium. Reduction in the price of a particular item makes the consumer spend less on their wages thus have low impacts on the high wages.
Higher interest rates
High interest rates make the budget constraint become steeper and shift outward. The change occurs because higher interest rates may result in stores purchasing goods at a higher price and the increased expenses are passed on to the consumer through high retail pricing. Even if the expenditure of the consumer is high, the higher interest rates remain high. Besides, the costs of living for all consumers become high with an increase in interest rates. With an increase in interest rates, consumers lack disposable income and therefore both consumer spending and budget constraints decreases. A decrease in consumers wealth decreases their consumption on their preferred item which might force the market to lower higher interest rates.
The role asymmetric information has in many economic transactions.
The rise of asymmetric information was in the 1970’s and 1980’s in an attempt to explain common phenomena that caused equilibrium economic issues which were unexplainable such as the Giffen goods theory. The theory states that an inequality of information between consumers and producers can result in ineffective consequences in certain markets. George Akerlof, Joseph Stiglitz, and Michael Spence developed the theory, and in 2001 they received the Nobel Prize in economics for their contributions (Ross, 2015). The impact of the theory of consumer choice is that if the consumer’s preferred commodity is on the high demand, it increases the role of asymmetric information in the economic transaction. That is consumers will increase their purchase power of a product that is well known to them even when the prices are high and leave the product they have little information about even with the low prices (Roberts, 2015).
The Condorcet Paradox and Arrow's Impossibility Theorem in the political economy
Condorcet Paradox or the voting paradox is the preferences between a set of choices, and the outcomes and variables of the set options for example for good A, B and C. with Condorcet paradox there are both winners and cycles. The winner has the majority votes against other alternatives. Voting paradox happens when there exists a transitivity violation in the social preference ordering (Aziz, 2015). In a political economy, there is one preferred item that is not uniformly consumed and may lead to a conflict situation. For example, if there are three candidates A, B. C which is to be voted in, and A is chosen, there may arise arguments in which B and C supporters want their candidates to win leading to a cyclic situation.
The impossibility theorem by Kenneth Arrows assumes that consumers have rational preferences over alternatives. The theorem does not use dictators but rather transitivity, unity, and independence of irrelevant alternatives ( Arrow and Lind, 2014) . In the political economy, the theorem states that every individual has the rank of order of preferences and people chose a product or a person depending on their importance. In a similar situation, if the parties involved employ the theory of consumer choice, there will have a preferred consumer choice, and political economy consumers will make a decision depending on the importance of the candidates. That is, they will choose a person who can satisfy their needs and leave the alternative. They make a choice with no dictatorship.
People are not rational in behavior economics.
The traditional economic theory of consumers assumes that consumers are rational when making consumption choices which may cause the demand curve to decline, however, irrational behavior exists negatively. Irrational people in behavior economics choose a commodity according to the levels of satisfaction.
Various factors influence the supply and demand curve in a market situation. Informed consumers make their decisions based on their budget constraints, and consumer preference represents a rational behavior and maintains the demand curve in equilibrium. These should be the factors affecting a consumer’s choice, not the brand loyalty so as to enjoy a stable and long-term financial situation.
References
Arrow, K. J., & Lind, R. C. (2014). Uncertainty and the evaluation of public investment decisions. Journal of Natural Resources Policy Research , 6 (1), 29-44.
Aziz, H. (2015). Condorcet's Paradox and the Median Voter Theorem for Randomized Social Choice. Economics Bulletin , 35 (1), 745-749.
Roberts, M. R. (2015). The role of dynamic renegotiation and asymmetric information in financial contracting. Journal of Financial Economics , 116 (1), 61-81.
Ross, S. (2015). What is the theory of asymmetric information in economics. Investopedia . Retrieved from http://www.investopedia.com/ask/answers/042415/what-theory-asymmetric-information-economics.asp
