The Theory of Consumer Behavior

THE THEORY OF CONSUMER BEHAVIOR

Consumers play an important role in the economy since they spend most of their incomes on goods and services produced by firms. In other words, they consume what firms produce. Thus, studying the theory of consumer behavior is quite important. What is the ultimate objective of a consumer?

Economists have an optimization model for consumers, similar to that applied to firms or producers. While firms are assumed to be maximizing profits, consumers are assumed to be maximizing their utility or satisfaction. Of course, more goods and services will, in general, provide greater utility to a consumer. Nevertheless, consumers, like firms, are subject to constraintsheir consumption and choices are limited by a number of factors, including the amount of disposable income (the residual income after income taxes are paid for). The decision to consume by consumers is described by economists within a theoretical framework usually termed the theory of demand. The demand for a particular product by an individual consumer is based on four important factors. First, the price of the product determines how much of the product the consumer buys, given that all other factors remain unchanged. In general, the lower the product's price the more a consumer buys. Second, the consumer's income also determines how much of the product the consumer is able to buy, given that all other factors remain constant. In general, a consumer buys more of a commodity the greater is his or her income. Third, prices of related products are also important in determining the consumer's demand for the product. Finally, consumer tastes and preferences also affect consumer demand. The total of all consumer demands yields the market demand for a particular commodity; the market demand curve shows quantities of the commodity demanded at different prices, given all other factors. As price increases, quantity demanded falls. Individual consumer demands thus provide the basis for the market demand for a product. The market demand plays a crucial role in shaping decisions made by firms. Most important of all, it helps in determining the market price of the product under consideration which, in turn, forms the basis for profits for the firm producing that product. The amount supplied by an individual firm depends on profit and cost considerations. As mentioned earlier, in general, a producer produces the profit maximizing output. Again, the total of individual supplies yields the market supply for a particular commodity; the market supply curve shows quantities of the commodity supplied at different prices, given all other factors. As price increases, the quantity supplied increases. The interaction between market demand and supply determines the equilibrium or market price (where demand equals supply). Shifts in demand curve and/or supply curve lead to changes in the equilibrium price. The market price and the price mechanism play a crucial role in the capitalist systemhey send signals both to producers and consumers.