Consumer Theory

Consumer Theory

Consumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in economics. Consumer choice theory is a way of analyzing how consumers may achieve equilibrium between preferences and expenditures by maximizing utility as subject to consumer budget constraints.

Preferences are the desires by each individual for the consumption of goods and services that translate into choices based on income or wealth for purchases of goods and services to be combined with the consumer's time to define consumption activities. Consumption is separated from production, logically, because two different consumers are involved. In the first case consumption is by the primary individual; in the second case, a producer might make something that he would not consume himself. Therefore, different motivations and abilities are involved. The models that make up consumer theory are used to represent prospectively observable demand patterns for an individual buyer on the hypothesis of constrained optimization. Prominent variables used to explain the rate at which the good is purchased (demanded) are the price per unit of that good, prices of related goods, and wealth of the consumer.

The fundamental theorem of demand states that the rate of consumption falls as the price of the good rises. This is called the substitution effect. Clearly if one does not have enough money to pay the price then they cannot buy any of that item. As prices rise, consumers will substitute away from higher priced goods and services, choosing less costly alternatives. Subsequently, as the wealth of the individual rises, demand increases, shifting the demand curve higher at all rates of consumption. This is called the income effect. As wealth rises, consumers will substitute away from less costly inferior goods and services, choosing higher priced alternatives.