Theory of Consumer Preference: Reasons and Main Principles
In the realm of economics, understanding consumer behaviour is crucial. This is where consumer choice theory comes into play, a fundamental concept that helps explain why individuals make different choices in similar situations.
Three Key Axioms
The theory is based on three axioms: Complete preferences, Transitive preferences, and Nonsatiation.
Complete preferences mean that for any two consumption bundles, a consumer can always state a preference for one over the other or be indifferent. This ensures that consumers can rank all alternatives, which is crucial for defining a utility function that represents choices.
Transitive preferences imply consistency in choice: if a consumer prefers A over B and B over C, then the consumer must prefer A over C. This property avoids cycles and contradictions, enabling stable decision-making and guaranteeing that maximization of preferences leads to well-defined optimal choices.
Nonsatiation (or local nonsatiation) means that more of at least one good is always preferred, implying consumers always prefer strictly better bundles. This drives demand behavior by ensuring that consumers keep preferring more desirable bundles, which affects the shape and slope of indifference curves and demand functions.
Making Choices
These axioms simplify modeling but are also sometimes relaxed in advanced economic theory to handle indecisiveness or incomplete preferences. Together, they allow economists to represent preferences with a utility function, making consumer choice a problem of utility maximization subject to budget constraints. Nonsatiation ensures that optima occur at budget constraints rather than interior points, reflecting realistic behaviour that consumers desire more rather than less.
Applying Consumer Choice Theory
Let's consider an example: choosing between two baskets of goods (Basket A: 7 oranges, 5 apples, and Basket B: 6 oranges, 6 apples) based on personal preference. In this case, the consumer chose basket B (6 oranges, 6 apples) over basket A (7 oranges, 5 apples) because it had more apples.
However, it's important to note that the theory does not account for the consumer's budget or income, which are important factors in consumer choice. The consumer's choice is also influenced by their current needs and inventory. For instance, in the given example, the consumer chose basket B because they needed to fill a run-out refrigerator.
Related Concepts
The concepts of utility, substitution effects, income effects, and the law of diminishing marginal utility are related to consumer choice and will provide further understanding. Consumer choice theory links consumer demand with preferences, assuming consumers fully understand their choices.
Conspicuous consumption, a related concept in economics that deals with the desire to consume goods as a means of displaying wealth or status, is not directly mentioned in this context.
In summary, these concepts provide the logical and mathematical foundation for consumer choice: completeness and transitivity create a consistent and comprehensive preference ordering, while nonsatiation motivates consumers to prefer larger bundles, all together enabling models that predict and explain economic behaviour effectively.
Investing in the understanding of consumer behavior, particularly through consumer choice theory, can significantly aid in business decisions. This theory, founded on the axioms of complete, transitive, and nonsatiation preferences, simplifies modeling of consumer choices, transforming the problem of consumer choice into a utility maximization subject to budget constraints in finance.
