Theory of Consumer Choice and Frontiers of Microeconomics - Paper Example

A consumer is an individual who utilizes the products offered by a company. They are thus paramount to an organization's existence since through their consumption they influence the purchase of goods or services offered by an organization. The understanding of how consumers make economic decisions would enable the marketing department to formulate effective strategies thus ensuring that the firm maximizes on their investment. The marketers may be able to understand their consumers through learning the theory of consumer choice that relates consumer's behaviors to factors such; demand curves, higher wages, and higher interest. They will also understand their customers through learning of the role that asymmetrical information has in economic transactions, and the Condorcet Paradox and Arrow's Impossibility Theorem in political economy.

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The Theory of Consumer Choice

The Theory of Consumer Choice highlights on how individuals spend their money. The theory mainly focuses on showing how people's choices relating to their tastes and income influence the demand curve of a firm's product. It utilizes factors such as the demand curve, high wages, and high-interest rates in describing consumers' practices. Demand relates to the willingness and ability of an individual to purchase a particular product (Frank 2009). A demand curve is a timely graphical representation that shows the relation between the prices offered at appropriate quantities of a commodity. The price and quantity demand of most products are usually inversely proportionate. This means, an increase in the price of the commodity usually causes a decrease in the quantity of goods or services demanded while a decrease in price cause an increase in the amount demanded.

A change in the price of a company's commodities usually causes movement along the demand curve. The changes in other factors other than price relating to the firm's commodities, on the other hand, would cause a shift in the demand curve. Higher wages would translate to an increase in the consumer's disposable income which would lead to an increase in the quantity bought by the consumer. The increase would result in a shift of the demand curve to the right since the price of the commodity would have remained the same. Higher interest rates would translate to the increase in the price of commodities offered by the business. The increase in price would have been caused by the increase in the cost of production incurred by the organization. The business desire to maintain their profit margin would thus force them to raise the price of their products to cover the increased rate margin. The quantity demanded by consumers would reduce due to the price increase. This change would lead to an upward movement along the demand curve indicating an increase in price and a reduction in the quantity demanded.

The role asymmetric information has in many economic transactions

According to Hubbard (2009), the theory of asymmetric information was introduced in the years between 1970 to 1980s by three economists Michael Spence, Joseph Stigliz, and George Akerlof. The three introduced the theory to explain phenomena that could not be explained by the general equilibrium economics principles. The theory shows how the imbalance of information between sellers and buyers would lead to uncertainty in the market. Akerlof in the year 1970 through a paper entitled "The Market for Lemons" showed how the lack of information might lead to market uncertainty. Akerlof utilized an example of a car seller and buyer. The car seller in this case usually possesses more information as compared to the purchaser. Thus they may use that information to their advantage. He argued that the seller may convince the buyer to purchase a bad car which he referred to as lemons at a higher price in comparison to the expected market price.

Michael Spence further expounded on Akerlof's argument through his 1973 paper "Job Market Signaling." In his paper, Spence highlighted that employers usually make an uncertain investment when they employ new employees since they do not know of their capability (Hubbard 2009). He also noted that the imbalance of information between employers and employees of low-paying jobs is what created an equilibrium trap that has caused a limitation in the bidding for higher wages under such markets. Joseph Stiglitz through the utilization of market screening theories enabled information asymmetry to reach its mainstream acclaim. His contributions enabled asymmetric information to be categorized into general equilibrium models that described negative externalities and their implications in the pricing of certain commodities in the market. An example of such is the uncertain health insurance premium required for individuals under high risk which causes all premiums to raise thus leading individuals under low risks to opt out from such policies.

The Condorcet Paradox and Arrow's Impossibility Theorem in the political economy

The Condorcet's Paradox is usually referred to as the voting paradox. It highlights on individuals preference under the consideration of different choices A, B, and C. In the existence of transitivity an individual would find for example choice A as the overall winner after comparing the three different choices between each other. However, in the absence of transitivity one may experience a Condorcet Paradox, where there will be an existence of cyclic winners. In such a situation all the options would be seen as the better option under different conditions thus making it impossible to point out the best option. Kenneth Arrow in his theorem Arrows Impossibility assumes that buyers possess rational preferences over alternatives (List 2013). In his theory, he includes the utilization of unanimity, transitivity, irrelevant alternatives independence and no dictators. The theory is a mathematical theory arguing that given certain conditions the combination of individual's social preferences values would be impossible.

People are not rational in behavior economics

Behavioral Economics is the study of psychology in relation to the economic decision-making processes that individuals or companies make (Camerer et al. 2011). Common demand curves are usually inversely proportional because of the rational behaviors of consumers that make them consistent and transitive. The rational behavior of consumers is majorly credited to the fact that individuals focus on ensuring they obtain the maximum utility from the commodities the purchase, while firms concentrate in ensuring they receive the maximum return on their investments from the profits they get. However, at times, consumers may possess irrational behaviors. This behavior is usually caused by the lack of adequate information which leads to the making of poor choices.

In conclusion, the understanding of consumers' behaviors in relation to the economic choices they make would be beneficial to an organization. This is because this information would enable them to formulate effective strategies relating to factors such as pricing thus allowing them to maximize their investment.

Reference

Camerer, C. F., Loewenstein, G., & Rabin, M. (Eds.). (2011). Advances in behavioral economics. Princeton University Press.Frank, R. H. (2009). Microeconomics and behavior. London: McGraw-Hill.

Hubbard, R. G. (Ed.). (2009). Asymmetric information, corporate finance, and investment. University of Chicago Press.List, C. (2013). Social choice theory.