CONSUMER THEORY
is the study of how people decide to spend their money
based on their individual preferences and budget
constraints.
A branch of microeconomics, consumer theory shows
how individuals make choices, subject to how much
income they have available to spend and the prices of
goods and services.
An understanding how consumers operate makes it
easier for vendors to predict which of their products will
sell more and enables economists to get a better grasp
of the shape of the overall economy
Consumer theory is the study of how people decide to
spend their money based on their individual preferences
and budget constraints.
Building a better understanding of individuals ' tastes
and incomes is important because these factors impact
the shape of the overall economy.
Consumer theory is not flawless, though, as it is based
on a number of assumptions about human behavior.
TYPES OF CONSUMERS:
Loyal Customers- are those who have made a
commitment to your product or service. Even though
they may comprise the smallest percentage of your
overall consumer base, your loyal customers are also
the most likely to generate the majority of your income.
As an added bonus, they're far more likely to
recommend your company to others. However, it's
important not to make the mistake of taking loyal
customers for granted — they ' re as likely as anyone
else to move on to greener pastures if your business
isn't meeting their needs and preferences. It' s essential
to keep this customer base involved, engaged, and
feeling as if they ' re valued by your company. Consider
adding reward programs and interactive social media to
keep them coming back.
Impulse Shoppers- are those simply browsing products
and services with no specific purchasing goal in place.
This consumer segment generates significant revenue
for most retailers. This type of consumer is usually
receptive to upselling and has the potential to become a
loyal customer if products and services meet or exceed
their expectations and desires.
Bargain Hunters- are seeking the best deal, period, and
most likely won 't be swayed by upselling techniques —
in fact, this may cause them to move on. This type of
customer has very little potential to become a loyal
customer unless it' s part of your business strategy to
offer the lowest possible price points at all times. This
customer also rarely, if ever, makes purchases on
impulse. Advertising sales is the best way to appeal to
those in this customer group.
Wandering Consumers - are somewhat related to
impulse shoppers, but they ' re much less likely to make
purchases. This type of customer is more prevalent in
brick-andmortar locations, but they do stumble into
online retail venues on occasion. It' s sometimes
possible to make a sale to those just wandering through
provided you can stimulate their interest, but keep in
mind that many of them are simply attracted to the social
interaction of shopping and have no intention of making
a purchase
Need-Based Customers- are driven by the need for a
specific product or service. Although these customers
generally make purchases decisively and quickly once
they find what they ' re seeking, they ' re easily lured
away by competing businesses. However, they ' re
frequently converted into loyal customers. They often
have practical questions or concerns that can be
addressed with a proactive social media presence.
Discount Consumers- are always on the hunt for
discounts, as the name suggests. Like loyal consumers,
they also have a tendency to frequent the same
organizations and brands. However, they only make
purchases when there is some kind of sale or discount.
To market to the discount consumer, you need to
advertise your offers and specials! Social media is a
great way to share sales and ongoing promotions, as are
personalized emails or brochures. If you have a sale
going on, you need to let your customers know.
CONSUMER PREFERENCES Individuals have the
freedom to choose between different bundles of goods
and services. Their preferences will be based on the
satisfaction they will gain from consuming these goods
and services.
MARKET BASKET - group of items that a consumer
will consider for consumption
FOUR ASSUMPTIONS ABOUT PREFERENCES
Consumer theory seeks to predict their purchasing
patterns by making the following FOUR basic
assumptions about human behavior:
COMPLETE - Individuals are able to make choices and
rank their preferences for different goods and services 1.
Mc Donald’s’ Shake Shake Fries
2. Jolly Crispy Fries
3. Potato Corner Fries
TRANSITIVITY - Individuals are rational in the choices
they make. Rational - Economists assume that people
will make choices in their own self-interest. They will
choose those things that provide the greatest personal
benefit, and they 'll avoid or forego those that aren 't as
personally valuable and compelling.
NONSATIATION - More is preferred to less. Greater
quantities provide greater levels of satisfaction to the
individual.
• The assumption that a consumer will always benefit
from additional consumption.
• The demand for some goods may have a finite limit,
but it is likely that there is some good or service a
consumer would benefit from having more of.
• More is better.
• Consumers prefer more to less.
DIMINISHING MARGINAL UTILITY - Additional units
consumed provide less additional satisfaction relative to
previous units consumed (the more you have of a
particular good, the less satisfaction you receive with
additional consumption of that same good). Consumers
prefer bundles (or combinations) of goods and services
that contain some variety of those goods rather than
extreme bundles that contain large amounts of just one
particular good.
INDIFFERENCE CURVES- From these assumptions,
we develop a consumer’s indifference curve that shows
alternative combinations of two goods that provide the
same level of satisfaction or utility.
INDIFFERENCE CURVE - shows all market baskets
where the consumer has the same level of satisfaction
UTILITY MAXIMIZATION - Economists use the term
utility in a peculiar and idiosyncratic way. Utility refers
not to usefulness but to the flow of pleasure or
happiness that a person enjoys—some measure of the
satisfaction a he experiences. Usefulness might
contribute to utility, but so does style, fashion, or even
whimsy. It’s a satisfaction that a consumer receives from
a market basket.
INDIFFERENCE MAP - shows multiple indifference
curves
CHARACTERISTICS OF INDIFFERENCE CURVE
Downward sloping
>Due to non-satiation
>If more of one received, less of the other must be
received to balance gain in satisfaction
The indifference curve is drawn as a downward
slope from left to right; in other words, it is negatively
sloped. This is because as the consumer increases the
consumption of a particular commodity (X), he or she
must sacrifice units of the other commodity (Y) to
maintain the same level of satisfaction.
Indifference curves are convex to the origin – this is
an important property of indifference curve. They are
convex to the origin, representing a diminishing marginal
rate of substitution. The Marginal Rate of Substitution is
the rate at which the consumer must sacrifice units of
one commodity to obtain one more unit of another
commodity. The consumer is willing to trade off one
good for another and still maintain a constant utility level.
But as more X is consumed, extra satisfaction received
will be less.
Higher indifference curve => higher utility
An indifference curve is drawn on a budget constraint
diagram that shows the tradeoffs between two goods. All
points along a single indifference curve provide the
same level of utility. Higher indifference curves represent
higher levels of utility.
Indifference curves don’t intersect with each other
The indifference curves cannot intersect each other. It is
because at the point of tangency, the higher curve will
give as much as of the two commodities as is given by
the lower indifference curve.
SLOPE OF INDIFFERENCE CURVE
MARGINAL RATE OF SUBSTITUTION - maximum
amount of one good (Y) a consumer is willing to give up
for one additional unit of another good (X)
MARGINAL UTILITY - additional satisfaction received
when consuming one additional unit of a good
LAW OF DIMINISHING MARGINAL UTILITY - as more
of a good is consumed, the extra satisfaction received
decreases
UNUSUALLY SHAPED INDIFFERENCE CURVE
PERFECT COMPLEMENTS - must use products in
fixed proportions Two goods are perfectly
complementary when we cannot consume one good
without consuming the other. This does not mean that
we need to consume the same amount of the two goods,
just that the two goods must be consume in certain
proportions.
Since complementary goods can only be consumed
together, then indifference curves must be right angles.
This is due to the fact that complementary goods will
always be consumed together and in certain proportions.
For example, in order to use the car, we need a certain
amount of gasoline per mile. If we could have more
gasoline, we would not be able to use it.
PERFECT SUBSTITUTES - consumer considers that
products exactly the same. These are those goods that
price is the only difference between the two. If two goods
X and Y are perfect substitutes, the indifference curve is
a straight line with negative slope.
ECONOMIC GOOD - a good or service that has a
benefit (utility) to society. Also, economic goods have a
degree of scarcity and therefore an opportunity cost. It is
the scarcity which creates opportunity cost.
PRIVATE GOOD – a product that must be purchased to
be consumed, and consumption by one individual
prevents another individual from consuming it. In other
words, a good is considered to be a private good if there
is competition between individuals to obtain the good
and if consuming the good prevents someone else from
consuming it.
KEY TAKEAWAYS
>Private goods are those whose ownership is restricted
to the group or individual that purchased the good for
their own consumption.
> A private good is not shared with anybody else, but
can be sold along with transferring rights to use or
consume it.
> Private goods are different from public goods, which
are available to everyone regardless of income levels.
Understanding Private Goods
We encounter private goods every day. Examples
include a dinner at a restaurant, a grocery shopping,
airplane rides, and cellphones. A private good is thus
any item that can only be used or consumed by one
party at a time. Many tangible home goods qualify, as
they can only be used by those who have access to
them. Any item that is effectively destroyed or rendered
unusable for its original purpose through use, such as
food and toilet paper, are also private goods.
Often, private goods have finite availability, making them
excludable in nature by preventing others access to it.
For example, only a certain number of a certain pair of
designer shoes are produced, so not everyone can have
those shoes even if they wish to purchase them. Not
only is a single pair seen as a private good, but the
entire product line can be classified as such.
The majority of private goods must be purchased for a
cost. This cost offsets the fact that the use of the good
by one prevents the use of the good by another.
Purchasing the item secures the right to consume it and
compensates the producer for the costs involved in
making it
PUBLIC GOOD - refers to a commodity or service that is
made available to all members of a society. Typically,
these services are administered by governments and
paid for collectively through taxation. These goods are
generally open for all to use and consumption by one
party does not deter another party ' s ability to use it. It is
also not excludable; preventing the use of the good by
another is not possible. Many public goods can be
consumed at no cost.
KEY TAKEAWAYS
 Public goods are commodities or services that benefit
all members of society, and which are often provided for
free through public taxation.  Public goods are the
opposite of private goods, which are inherently scarce there are numerous variables that can expose the
and are paid for separately by individuals. process of simplifying spending habits as flawed.

 Societies will disagree about which goods should be SUMMARY

considered public goods; these differences are often
reflected in nations’ government spending priorities.
How Public Goods Work
The two main criteria that distinguish a public good are
that it must be non-rivalrous and non-excludable.
Non-rivalrous means that the goods do not dwindle in
supply as more people consume them; non-
excludability means that the good is available to all
citizens.
An important issue that is related to public goods is
referred to as the free-rider problem. Since public goods
are made available to all people–regardless of whether
each person individually pays for them–it is possible for
some members of society to use the good despite
refusing to pay for it. People who do not pay taxes, for
example, are essentially taking a "free ride " on
revenues provided by those who do pay them, as do
turnstile jumpers on a subway system.
 Each person determines his or her own preferences
and utility. Thus, while indifference curves have the
same general shape—they slope down, and the slope is
steeper on the left and flatter on the right—the specific
shape of indifference curves can be different for every
person.
 People seek the highest level of utility, which means
that they wish to be on the highest possible indifference
curve. However, people are limited by their budget
constraints, which show what tradeoffs are actually
possible.
 Building a better understanding of individuals' tastes
and incomes is important because these factors impact
the shape of the overall economy.
 Consumer preference determines what products
people will buy within their budget. Understanding
consumer preference will give you an indication of
consumer demand. This information will help to ensure
that you have enough product to meet demand and will
help you determine the price for your product.

ECONOMIC BADS - one product is undesirable; less is

preferred to more. These are commodities that lowers a
consumer ' s level of happiness as their consumption
increases.

POINTS TO REMEMBER KEY TAKEAWAYS

 Consumer theory is to demand as producer theory is
to supply.
 Consumer theory is based on the premise that we can
infer what people like from the choices they make.
 Utility refers not to usefulness but to the flow of
pleasure or happiness that a person enjoys—some
measure of the satisfaction a person experiences.
 There are no natural units for utility; any increasing
transformation is acceptable.

ADVANTAGES OF CONSUMER THEORY

Building a better understanding of individuals ' tastes
and incomes is important because it has a big bearing
on the demand curve, the relationship between the price
of a good or service and the quantity demanded for a
given period of time, and the shape of the overall
economy.
 Consumer spending drives a significantly large chunk
of gross domestic product (GDP) in the U.S. and other
nations. If people cut down on purchases,
demand for goods and services will fall, squeezing
company profits, the labor market, investment, and many
other things that make the economy tick.

Consumer choice theory is taken very seriously,

influencing everything from government policy to
corporate advertising.

LIMITATIONS OF CONSUMER THEORY

 Challenges to developing a practical formula for this
situation are numerous. For instance, as behavioral
economics points out, people are not always rational and
are occasionally indifferent to the choices available.
Some decisions are particularly difficult to make because
consumers are not familiar with the products. There
could also be an emotional component involved in the
decision-making process that isn 't able to be captured in
an economic function.

 The many assumptions that consumer theory makes

means it has come under heavy criticism. While its
observations may be valid in a perfect world, in reality