Consumer choice theory links the consumer demand curve with consumer preferences. This theory views that consumers fully understand what they choose.
The rationale behind consumer choice theory
When dealing with several consumption bundles, consumers learn and compare them. They will choose the best (which produces the highest utility).
For example, you want to buy apples and oranges. The seller then offers you two baskets of goods. Basket A contains 7 oranges and 5 Apples, while basket B contains 6 oranges and 6 Apples. Assuming the price and total amount are both equal, you then choose basket B because it is what you want.
When faced with a similar situation, your friend might choose basket A, instead of basket B like you. He reasoned that basket A was more suited to his needs, for example, because he still had some oranges in the refrigerator.
Consumer choice theory tries to explain such situations. When we study consumer choice behavior, we examine how consumers decide which products to buy or consume.
In economics, consumer choice depends not only on the satisfaction (utility) of the product but also on their budget lines. Thus, optimum consumer choice is when the selected product provides maximum satisfaction and is affordable with their money. In a graph, the optimum choice occurs at the point of intersection between the indifference curve and the budget constraint line. We call this point consumer’s equilibrium.
Furthermore, our choice also depends on our income and the price of alternative goods. The concepts of income and substitution effects seek to explain them. Both deal with how changes in the price of an item change our choices and consumption. Trade-offs and consumption decisions that we make when prices and incomes change are also part of consumer choice theory.
Why consumers have to choose
Consumers make choices because they cannot have everything they want. This is the basic idea of economics.
Our desires are unlimited, while our resources are limited. For example, when shopping, we want to buy all the things we want. However, we know it is impossible because we do not have enough money (resources).
Therefore, we must choose. All choices involve opportunity costs. If we choose something, that means we also give up and not accept the next best alternative.
Economic choices require comparing both resources and utilities. As consumers, the budget represents the resources we have, and satisfaction represents the utility of consumption.
Axioms of the consumer choice theory
Three axioms that underlie consumer choice theory are:
- Complete preferences
- Transitive Preferences
The theory assumes the consumer fully understands his decision. When dealing with several basket alternatives and must choose one, consumers compare them based on their preferences.
That way, they can positively state which basket they prefer. In the previous case, you chose basket B because it contained 6 oranges and 6 apples. It would be best if you had both of them to fill the refrigerator that has run out. So, that choice suits your needs.
In other scenarios, you might not choose basket A or B. The reason may be because you still have both in the refrigerator.
This assumption involves the conclusion of more than two choices. Suppose, you are given three bundles, A, B, and C. You prefer to bundle A rather than bundle B. And, compared to bundle C, you still prefer bundle B. Therefore, we can conclude, when you face bundles A and C, then you will undoubtedly choose bundle A.
This axiom says that more is better. If the consumer faces two bundles that are almost identical A and B, but B includes more than one particular item, the consumer will choose B.
For example, in the previous case, you chose basket B, which contained 6 oranges and 6 Apples. It would be best if you had oranges and apples in equal amounts. You don’t like basket A because it includes fewer apples (5 pieces).
In some instances, the consumer has so many items that he will refuse more items, even if it’s free.