Consumer Theory - Explained

What is Consumer Theory?

What is Consumer Theory?

Consumer theory refers to the study of how buyers tend to spend their money due to their preferences and budget constraint. Budget constraint refers to the limit on what a consumer can buy due to the limited resources which he or she has. Preferences, on the other hand, refers to the way that a consumer decides to satisfy his or her desires. Consumer theory is a branch of microeconomics under the section of consumers behavior. This subject highlights the different ways in which a consumer makes purchasing choices due to constraints like income, or the amount of output available. Consumer theory helps us to get a proper understanding of how income levels and buyers desires influence the demand curve. Behavioral economics is one of the most critical aspects of an economy, and it helps to shape its performance.

How does Consumer Theory Work?

A rational consumer would choose the product that brings the most satisfaction to him even when he has a variety of goods to select from. If John loves chocolate more than pizza, he will be more willing to purchase 2 chocolate bars over 4 pizzas if he acts rationally. To analyze consumer theory, the following inputs must occur:

• A range of consumption options
• The satisfaction in terms of utils derived from consuming different products from his or her range of options
• The price of each bundle
• The amount of bundle, the buyer, possesses.

Illustration of Consumer Theory

Let us assume that Jane, who has just \$300 (this is her budget restraint) must choose how to maximize her funds in purchasing candies, pizzas, and tacos. If a candy bar costs \$30, a pizza costs \$20, and a taco costs \$25, Jane can purchase a combination of all three since one unit of each added together would not move past \$300 (\$30+\$25+\$20 = \$75). Jane can also purchase two or three units of each without exhausting her \$300. Given her current budget constraint, Jane can purchase 4 units each of all three products, but cannot purchase more. However, how can we predict how Jane is going to spend her \$300? Jane could also decide to keep her \$300 in her purse since behavioral economics also covers why a consumer wouldnt want to make a purchase. To be able to predict how Jane would spend her money, or whether Jane would spend her money, one must make use of consumer theory, which provides a near-perfect answer to related questions.

Shortcomings of Consumer Theory

Irrationality is the biggest issue with consumer theory, as people dont always make the best choices in life. Consumers can also make last-second changes to their desires, and this would also have an effect on consumer theory. Other factors that limit the ability of this theory include; emotional decisions (currently following market trends even if it isnt at the top of the consumers preference list), hard time making decisions, or fear of products, especially by first time users. In order to outdo these shortcomings, consumer theory will make several assumptions to simplify the process. In the above example, this theory can assume that Jane understands her desires for tacos, candies, and pizzas, and she can decide which one gives her the most satisfaction. It also assumes that Jane is rational and thus, she understands what she really wants (which wont occur almost all the time). Lastly, consumer theory would predict that all of Janes desires at that moment (candies, pizzas, and tacos) are available to the point that each of them has enough units to surpass her budget constraints. In other words, there are enough candies at the shop to exhaust \$300. Same goes for pizzas and tacos.