THEORY OF CONSUMER CHOICE 8
Theoryof Consumer Choice
Theoryof Consumer Choice
Thetheory of consumer choice highlights the need for companies toanalyze and understand how their clients make their economicdecisions. Consumer choice refers to customers decisions regardingtheir use of certain products and services (Thaler, 2013). A companymust evaluate the effect of the theory of consumer choice on theinterest rate, wages levels, and demand. The theory of consumerexplains how wages affect the level of labor supply besides, itdetermines how interest rates affect household savings. Lastly, ithelps in the analysis of the demand curve (Bernanke, 2015). Analysisof consumer behavior allows economist and marketers to examine howconsumer decision impacts the long-term purchasing behavior of aparticular product or service.
Additionally,the theory conceptualizes the link between consumer preferences,propensity to consume, and related demand curves (Cowen, 2015). Thetheory describes how individuals or households choose to spend theirincome based on their preferences and budgetary constraints. Manyhouseholds or individuals consume less than what they truly wish. Theconsumer spending is greatly constrained or restricted by theavailable dispensable income (Thaler, 2013). An individual earning $9per hour might be unable to purchase certain premium or luxuriousproducts due to the high or premium prices being charged. Forinstance, many people cannot afford the watch because of its high orpremium price. As a substitute, people are forced to buy the Androidsmart watch which is more affordable compared to the Apple smartwatch. Similarly, the pricing affects demand of the product sincepeople are unable to afford the product or service despite the demandbeing very high (McFadden, 2014).
Ademand curve illustrates how service or product demand changes giventhe fluctuation in prices. For example, On October 11, 2015, AppleInc. introduced into the market the US$599 smart watch. The companysurpassed its sales targets as 2.3 million units were sold globallyin the first week of its introduction into the market. Revenue fromthe sales of the watch amounted to nearly US$300 million.Furthermore, demand increased greatly in the subsequent weeks.Additionally, as prices of product and services reduce, customerswill likely purchase the commodity which in turn increases demand(Bernanke, 2015).
Similarly,as prices increase, many customers will withdraw or stop buying theproduct. The customers will likely switch to other alternative orsubstitute products in the market. For instance, they will preferbuying Android and Motorola brands which are more affordable(Lancaster, 2013). The consumer theory shows how customers makechoices based on their level of disposable income and the price ofthe commodity. Besides, it helps marketers understand how customers’taste, preference, and income level impact the demand curve (Thaler,2013).
Aperson’s income or wage level contributes to his/her budgetaryconstraints which affect the propensity to consume (Bernanke, 2015).Mostly, an increase in total income levels reduces budgetaryconstraints. Hence, consumers can choose a great combination of goodsand services on a higher indifference curve (Cowen, 2015). Higherwages level means individuals and households have higher levels ofdisposable income which increase their purchasing power. A performingeconomy increases wage levels allowing people to spend and save more.
Individualsand households spending are tied to their income levels. In the caseof a normal good, a consumer will spend more on the product whenhis/her income increases (Lancaster, 2013). Alternatively, in thecase of an inferior good, consumers usually spend minimallyirrespective of an increase in their level of income or wage. Ifconsumers wage level is low, their spending would be reduced as theirpurchasing or buying power is substantially diminished. According toCowen (2015), a low level of purchasing power impacts the economynegatively as it largely depends on consumers’ spending.
Marketersshould understand the impact of the consumer choices on the level ofthe interest rates. Consumer purchasing power or propensity toconsume is greatly affected by the changes in the levels of interestrates (Thaler, 2013). Such factors like consumer confidence, economicstatus, and projected future rate changes affect consumer spending.If interest rates increase or decrease, consumer spending or savingcorrespondingly increase or decrease. The impact of changes ininterest rates largely depends on consumer attitude regarding thefeasibility of saving or spending in relation to the change.Consumers will likely increase their savings when interest ratesincrease as they anticipate higher rates of return (Cowen, 2015).
Furthermore,an increase in interest rates is usually followed by an increase ininflation. Hence, consumers will increase their spending if they areconvinced that the purchasing power of the dollar will depreciate dueto the inflation. The increase in customer spending can be attributedto decrease in interest rates (Bernanke, 2015). Low levels ofconsumer confidence about the future income prospects and possibilityof a depressed economy negatively impact consumer spending.Furthermore, reduced levels of consumer spending affect the demandfor products and services in the economy (Thaler, 2013).
TheRole of Asymmetric Information
Asymmetricinformation refers to a scenario whereby one party in an economictransaction has superior information as compared to the other party(Erdem, 2013). A seller has more information than the buyer. Hence,it is likely that the seller will exploit the buyer since he lacksthe relevant knowledge or information. For example, Apple Inc.outsourced or offshored its production functions to China because ofthe availability of cheap labor to reduce its operational costs. TheiPhone cost almost $35 per unit to produce and then it retails thephone at $599. The consumers are unaware of such information.
Imperfectinformation discourages sellers and buyers from participating in themarketplace. For buyers, they become hesitant to participate if theyfail to determine the product’s quality (Trevisan, 2016). While,sellers can be reluctant to sell high-quality products since theycannot comprehensively attest the quality of the goods to the buyers.As buyers fail to determine the quality of goods they might not bewilling to purchase the goods at a high price. The case leads to athin market because of the imperfect information. The prevalentconditions affect the aggregate demand and supply. Hence, marketersmust strive to communicate adequate information about the ‘lemon’or the product with uncertain quality to increase its sales volume(Erdem, 2013). The company can introduce service contracts,warranties, money-back guarantees, as well as strengthening thereputation of the product to increase customer confidence and demand.
TheCondorcet Paradox and Arrow`s Impossibility Theorem
Condorcetwas convinced that voting in the political arena is meant todetermine what choice is best for the whole society. The choices canbe ranked as first, second, third, fourth best, and so on (Arrow,2014). Nonetheless, the paradox shows how a democratic voting systemfails to settle for the best outcome desired by entire society. Withregards to the Arrow’s Impossibility Theorem, the concept provedthat irrespective of the number of candidates in play no votingsystem or procedure meets all the four axioms. The four axiomsinclude unanimity, no dictators, independence of irrelevantalternatives, and transitivity (Kapeller, 2015).
Novoting system can transform the individuals` ranked preferences intoa society-wide ranking. The theories prove the inability of oursociety to make the right choices if they are more than two choicesthat might be ideal for the whole society (Arrow, 2014). Customersare usually very irrational. Hence, it is very hard for companies tomake all their customers happy. As a marketer, there is need tomonitor the pricing strategies as it contributes towards enhancingcustomer satisfaction and levels of demand (Kapeller, 2015).
People’sIrrationality in Behavior Economics
Consumersare usually irrational under certain circumstances. Under favorableconditions, many unhappy individuals and households are comfortableswitching loyalty to other competitors as an act of revenge. Acompany must strive to create customer loyalty to sustain or improveoverall demand of its products and services (Trevisan, 2016).
Companiesmust understand how consumers make their economic decisions tostrategies how best to increase their market share. The theory ofconsumer choice helps the company to analyze and understand howdemand, wage level, interest rates among other factors. Suchunderstanding helps the company to secure competitive advantage inthe market. Good understanding of consumer choices, pricing strategy,and providing a firm’s asymmetric information can be determiningfactors in improving corporate performance and profitability
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Cowen,T., & Tabarrok, A. (2015). ModernPrinciples of Microeconomics.Palgrave Macmillan.
Erdem,T., Swait, J., & Louviere, J. (2013). The impact of brandcredibility on consumer price sensitivity. Internationaljournal of Research in Marketing, 19(1),1-19.
Kapeller,J., Schütz, B., & Steinerberger, S. (2013). The impossibility ofrational consumer choice. Journalof Evolutionary Economics, 23(1),39-60.
Lancaster,K. J. (2013). A new approach to consumer theory. Thejournal of political economy, 132-157.
McFadden,D. (2014). The new science of pleasure: consumer choice behavior andthe measurement of well-being. Handbookof Choice Modeling,7-48.
Thaler,R. (2013). Toward a positive theory of consumer choice. Journalof Economic Behavior & Organization, 1(1),39-60.
Trevisan,E. (2016). TheIrrational Consumer: Applying Behavioural Economics to Your BusinessStrategy.Routledge.