Consumer theory explains how people make decisions. This involves how they are willing to spend their money based on their preferences and budgetary demands. The theory, therefore, illustrates how people make choices depending on their income and the cost of the products and services they want to purchase (Bordalo, Gennaioli, & Sheifer, 2012). Such understanding helps economists to have an insight of how preferences and income affect the demand curve. In that respect, this paper will discuss the impact that consumer choice has on demand curves, higher wages, and higher interest rates. In addition, it will examine the effects of this theory on asymmetric information, Arrow theorem and rationality of behavior in economics.
Demand curves
In many instances, the choices that consumers make are influenced by prices. The demand for many commodities is affected by changes in price (Bordalo, Gennaioli, & Sheifer, 2012) . For instance, an increase in the cost of a commodity leads to a decrease in demand for that particular product. Demand curves are generated by estimating the price that the customers are ready to pay for a certain quantity of goods and services. Typically, a curve that is sloping downwards is usually used to illustrate the demand for conventional products and services. In the curve, the quantity demanded (in the x-axis) will increase when there is a decrease in price (in the y-axis). Vice versa is also true. However, the curve can shift either upwards or downwards depending on the quantities of goods and services demanded. This is influenced by the price of a commodity, which on the other hand defines the choices that customers make. Therefore, the price is the primary factor that determines the purchasing decisions of consumers.
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Higher wages
Wage is another important element that affects consumer choice. The impact of earnings can be observed by noting variations in the purchasing trends. Based on the consumer theory, an increase in wage increases the products and services demanded. This is a direct implication that an increase in real income increases the purchasing power of the consumers. From income-consumption curves, it is also apparent that rising wages lead to a corresponding growth in quantity demanded. Just like for the demand curves, the income-consumption curves can shift upwards or downwards depending on the income that a customer gets. Graphically, if the prices remain to be constant, an increase in income will shift the budget constraint to the right (Bordalo, Gennaioli, & Sheifer, 2012). As a result, the customer will have more freedom to purchase goods and services depending on his/her tastes and preferences.
Higher interests
Interest rates have different effects on the manner in which a consumer spends. This depends on some factors such as the present rates, expected changes in rates, and consumer confidence. Interest rates can change either way. They can go upwards or downwards. Such changes affect consumers’ behavior. For instance, a consumer will have to determine whether to spend or save. Usually, when the interest rates are high, the majority of the consumer will be willing to save than to spend. Nevertheless, this depends on their attitudes pertaining to whether they are well off purchasing or saving in relation to changes in interest rates.
Importantly, higher rates would encourage the customers to increase their savings since they will be guaranteed better return rates. Notably, increases in interest rates are generally followed by high inflation rates. Such information may provoke customers to purchase more goods and services. This is true, especially when the consumers feel that inflation may erode their purchasing power. A decrease in interest rates may encourage consumers to exercise their purchasing power. Therefore, the choices that consumer make relating to whether to purchase or save chiefly depends on the present rates of interest and perceptions of the future trends.
Role of Asymmetric Information in Economic Transactions
Asymmetric information relates to a case where imperfect knowledge exist (Barbaroux, 2013). Typically, it takes place where there are two parties with contradicting information regarding particular products and services in the market. A real scenario is where a car a person is willing to sell a car. The interested seller, in this case, has full information relating to how he/she has been servicing his/her car and the possibility of it breaking down. After comparing, the interested buyer will be left in the dark and may eventually fail to trust the seller.
Asymmetric information affects businesses particularly in financial markets where there is a lot of lending and borrowing (Lewis, 2011). For example, a borrower is in a good position to tell his/her financial background better than the lender. In this regards, the bank cannot say whether the borrower would default. Somehow, the lender can overcome such fear by taking a look at the past borrowing trends and the salary of the borrower. Nevertheless, such information is not conclusive. As a result, the lender ends up increasing the interest rates to cover for the risk. This is an implication that if there had been perfect or rather sufficient information, banks and another lending would not be charging the risk premium.
The Condorcet Paradox and Arrow Impossibility Theorem in the Political Economy
The arrow’s “impossibility” or rather the “general possibility” theory as Kenneth advocated for it is a theory that provides information relating to decision-making. According to Kenneth, individuals have plenty of situations where they will have to make a choice. These could be in elections, projects, labor requirements, income distribution, or anything else that involves making decisions. There are particular categories of individuals whose tastes help them in making choices. However establishing protocols that would separate sound preferences from wrong is still a puzzle. Pertinent to that, this theorem believes that there are no procedures whatsoever that can be used to describe the autonomy that people have when making decisions about their tastes and preferences (Stodder, 2005).
People not being Rational in Behavior Economics
In economics, rational behavior is regarded to be one that involves making decisions that will benefit an individual. Most theories in economy assume that all people behave rationally. Rationality in this regards does not necessarily require the monetary or material benefits. This is because the satisfaction would be emotional oriented. A choice can be deemed rational if it is freed from emotional components during the decision-making process (Bourguingon, Ferreira, & Lustig, 2005). Besides, it should present facts as they appear. In addition to the elimination of psychological aspects, the element of determination in diverse aspects needs to be manifested if it can be explained logically. This may involve making decisions on whether to invest in a particular bond type or another that has the same interest rates as well as maturity dates.
Nevertheless, irrational behavior also exists in economics in relation to consumer choices. Irrational behavior has been a noted in some investors. Typically, this involves situations where they make decisions that are primarily based on emotional aspects. An investor, for instance, can opt to invest in a company that economic models have indicated a decline in performance. This decision is based on the positive feelings that an investor has towards that particular company (Barbaroux, 2013). Such choices are not wise hence are deemed as irrational behaviors. Another irrational behavior includes failure to dispose or rather sell a falling stock.
Conclusion
In conclusion, consumer theory is vital since it illustrates how people make choices. As this paper has revealed, the choices made by consumers income and price of goods and services they want to purchase. Such understanding helps economists to have an insight of how preferences and income affect the demand curve. Consumer choice defines the demand curve. It also determines how consumers make decisions on whether to spend or save to earn more benefits. Besides, asymmetric information and irrational behaviors are the factors that hinder consumer choice.
References
Barbaroux, P. (2013). From market failures to market opportunities: managing innovation under asymmetric information. Journal of Innovation and Entrepreneurship: A Systems View across Time and Space, 43 (5), n.p. doi: 10.1186/2192-5372-3-5
Bordalo, P., Gennaioli, N., & Shleifer, A. (2012). Salience and consumer choice (No. w17947). National Bureau of Economic Research . Retrieved from http://scholar.harvard.edu/files/shleifer/files/pdf_1.pdf.
Bourguignon, F., Ferreira, F. H., & Lustig, N. (Eds.). (2005). The microeconomics of income distribution dynamics in East Asia and Latin America . World Bank Publications.
Lewis, G. (2011). Asymmetric information, adverse selection, and online disclosure: The case of eBay motors. The American Economic Review , 101 (4), 1535-1546.
Stodder, J. (2005). Strategic Voting and Coalitions: Condorcet's Paradox and Ben-Gurion's Tri-lemma. International Review of Economics Education , 4 (2), 58-72. Retrieved online from http://www.economicsnetwork.ac.uk/iree/v4n2/stodder.htm.
