Consumption theory is a fundamental concept in the field of microeconomics. Its purpose is to study various economic decisions. The priority area of research is the process of consumption by private economic agents.
Components
The characterization of consumption theory should begin with the basics. The basic assumption in this concept is the principle of satisfying needs. It consists in the fact that the agent, that is, the subject of the consumption procedure, seeks to satisfy its own needs of a material and intangible nature. In fact, the process of obtaining the desired benefits is the main point of economic activity. The better the subject succeeds, the greater the benefit. In turn, the very concept of benefit (utility) plays a special role in the economy. This is a necessary condition for the acquisition of exchange value, that is, value. The more valuable the product, the more the needs of a particular person will be met.
The second fundamental element in consumption theory is preference. Subjects of the sphere of consumption have personal preferences and desires that correspond to their nature and personal characteristics. They all differ from each other. Preferences themselves are included in a special hierarchy. This suggests that economic agents put some benefits above others, that is, give them increased or decreased utility. The same pattern applies with combinations of benefits, that is, preference groups.
Utility function and rational behavior
One of the foundations of consumption theory is the utility function. This is the ratio between the number of benefits used and the utility resulting from them. If we are talking about combinations of tangible or intangible goods, coupled with utility, then their image will be executed in the form of indifference curves. An alternative to the search for consumer choice is the approach of preferences found. These are certain desires of people, information about which can be obtained by observing the behavior and characteristics of the economic agent.
Rational behavior completes the structure of consumption theory. Everything is quite simple here: the subject of the sphere of consumption is trying to achieve the maximum in meeting its own needs within the limits of the existing budget. He does this solely in his favor, achieved through the use of goods. All possible consumption processes that the subject has are located below the budget curve. This is the name of the combination of two goods that a consumer is able to buy if his finances have a fixed value. This implies the assumption that the subject acts in a rational manner. Additionally, it is indicated that supply and personal demand do not have any impact on market prices. Agents themselves are able to change only the number of goods consumed.
Subject decisions
Decisions of private agents are almost the main value in the theory of consumption. Consumer choice is divided into two types: solution of demand and solution of supply. Let's start with the characteristics of the first element.
Based on the budget available to the agent, demand is formed in the markets for the provision of various goods. The requested number of them depends solely on what kind of combination of benefits can bring the highest benefit to the subject. The choice is based on market prices for the goods themselves. Analysis of demand solutions allows us to identify personal demand functions. They, in turn, indicate the relationship between prices and demand. From here, by the way, the concept of elasticity of demand by value is taken. It also explains the relationship between income and demand. This is income elasticity of demand.
The second type of solution in consumption theory is related to supply. Each subject of the sphere of consumption is able to offer capital or work. He does this in the markets of production factors. The agent, therefore, makes two important decisions. The first decision is related to how much capital he wants to offer in the markets for production factors. Such a solution includes dividing the budget into spending, that is, consumption, and saving, that is, saving. In fact, these factors are a problem of maximizing utility within a given time. After all, the agent makes a choice between present and potential, that is, subsequent consumption. Such an analysis, by the way, provides an explanation of why there is a securities market and how it can increase the benefits.
The second type of supply decision is related to the amount of work and the desire to offer something in the markets of production factors. In this case, we are talking about the division of own time into free and labor. This kind of analysis provides personal job offer functions.
The proposed and requested numbers of subjective goods in consumption theory are considered interrelated. The thing is that both of these groups influence the budget available to the private agent.
Theory features
Having figured out the basics of this concept, you should begin to study its basic features. As you know, a person acquires services and goods in the process of almost all of his life. There are only two goals for this process: satisfying basic needs and getting pleasure. An important role is played by the choice made by the consumer.
It has long been proven in economic science that several factors influence the selection process. Their first group is called personality. This includes such concepts as age, life stage, earnings, the size of the existing or potential budget, the ability to earn money and more. In fact, it is a group of personality factors that has the greatest influence on a person’s choice.
In second place is a group of psychological factors. This includes the ability to selectively memorize, the skill of analysis, the possibility of a sober assessment of the situation, and much more. Some experts point out that personal, that is, psychological characteristics to a greater extent affect the choice in the field of pleasure.
The last two groups are called cultural and social. Everything is simple here. A person is greatly affected by the external environment, and especially society. Based on the characteristics of the world, a person makes one or another choice.
All the issues identified above are resolved in the economy in the framework of the theory of consumption. This theory studies the principles and main features of the rational behavior of people in the provision of services and goods. It also explains how a person is able to make a choice of market goods.
Many economists have contributed to the study of consumer theory. These are researchers of the institutional and sociological direction, representatives of the "development economy", some historians and even Marxists. The latter, by the way, have formed their theory, where they specifically outlined the problems of welfare. One way or another, the theory itself remains a lot of unresolved and simply controversial issues. The traditional study of this concept involves the study of consumption as a regular process for the disposal of goods, with its structure and special principles of movement.
Principles of the theory of consumer consumption: freedom of choice and rational behavior
The current concept is based on a number of important methodological principles. Each of them should be disassembled in detail and characterized further.
The first principle is consumer sovereignty and freedom of choice. You might think that the main actors in the consumption system are producers. In fact, it is they who determine the structure and volume of production, and also have the ability to influence the level of prices for services and goods. The result of their effective activity is the possibility of acquiring profits.
In such conditions, it is allowed to produce only those goods that can be sold on the market at a cost that exceeds production costs. At this point in the economic theory of consumption, the emphasis shifts from the field of production to the consumer environment. Suppose a buyer gives a certain amount of money for a product. It exceeds the costs allowed during production. This means that the manufacturer can continue its business. In a different situation, he is not able to sell his own product and suffers losses. As a result, he is completely ruined. All this testifies to the fact that consumer sovereignty is in effect in this area. The impact on the production structure and volume is provided by the consumer. To do this, they form a demand for specific services and goods.
An important point of consumer sovereignty is the freedom of consumer choice. Here, of course, a number of limitations can be identified. These are emergency situations - such as war or famine, as well as the desire to protect the population from harmful goods (such as drugs, cigarettes or alcohol). Among the restrictions is also the desire to provide citizens with some equality in consumption. This goal is motivated by social policies pursued by most developed countries.
The second principle is called rational human behavior in the economic sphere. Rationality lies in the desire of the consumer to correlate his income with such a set of benefits that would maximally satisfy all the necessary needs. Based on the principle of rationality, the theory of the function of consumption was formulated, which has already been considered above.
The rarity, utility and laws of Gossen
The principle of rarity is the third fundamental element in this concept. It indicates that the production of any product is limited. The principle of utility states that any acquired good in one way or another satisfies human needs. The principle of accounting for consumer income indicates the possibility of transforming needs into demand, if you give them a monetary form.
The latter principle is clothed in a series of laws that were formulated by the Prussian economist German Gossen. All basic consumption theories are based on the axioms that the scientist formulated. The first law states that it is necessary to distinguish between the general utility of the good from its marginal utility. Decreasing marginal positive qualities is the basis for the consumer to achieve equilibrium. This is a condition in which maximum utility is extracted from available resources.
The content of the second law states that obtaining maximum utility from the consumption of certain goods for a certain period of time should be based on the rational consumption of these goods. That is, it should be consumed in such quantities that the marginal utility of the goods consumed is equal.
Gossen says that a person who has freedom of choice, but does not have enough time, is able to maximize his enjoyment by partial use of all benefits before the direct consumption of the greatest of benefits.
Keynes's Theory of Consumption
Studying the concept under consideration, one cannot but mention the theory of John Keynes. In his view, consumption is a combination of goods and services that are purchased by customers. The amount of finance spent by the population for these purposes appears in the form of consumer spending. However, a part of household income is not used, but acts as a savings. The farm itself is recorded without government intervention and is indicated by the sign Yd. Consumer spending is C. Savings - S. Therefore, S = Yd - C. Consumption is closely related to national income.
The consumer function has the following form:
C = Ca + MPC * Y.
CA here is the value of autonomous consumption, which does not depend on disposable income. MPC is the marginal propensity to sell. In itself, a CA characterizes a minimum degree of C. It is necessary for people and does not depend on current disposable income. In the absence of the latter, people will take debt or reduce the amount of savings. The horizontal axis will postpone disposable income, and the vertical axis will show people's spending on needs.
Thus, the main provisions of the Keynesian theory of consumption are as follows:
- The marginal propensity to consume is a result greater than zero. However, it is less than one. As profit increases, its share, which has as its goal consumption, decreases. And all because rich people are more likely to save more than the poor.
- There are a number of factors that affect saving and consumption. These are taxes, deductions, social insurance and so on. All this affects the growth of taxes, and also reduces the amount of income. The level of savings and consumption is reduced.
- The greater the accumulated wealth, the weaker the incentive for savings. This principle is the basis of a separate theory of consumption and savings.
- A change in price level affects the value of financial assets.
Here, one should also take into account a number of psychological factors, such as greed, pleasure, generosity, and more. Structural elements also play a significant role: family size, age of its members, location, budget, and much more.
Relative income theory
Keynes's consumption theory was developed in the mid-19th century. For about a century, it was considered the only true one in economic science. But in the post-war period, several alternative concepts appeared, each of which should be analyzed in detail in our material.
The doctrine of relative income is considered quite common. This concept is firmly entrenched in the group of consumption theories and production theories. It was developed thanks to the American economist James Dusenberry. In 1949, the scientist suggested that the message about the definition of consumer spending as disposable income cannot be called fully reliable. Dusenberry argues that consumer decisions are prioritized by third party acquisitions. By them, the economist meant the closest neighbors.
The essence of the concept of relative income is quite simple: a person’s consumption is directly related to his current income. Moreover, the individual’s profit is compared with two factors:
- own profit received in the past tense;
- income neighbors.
The generally accepted concept of consumer demand indicated that customer satisfaction from the purchase was not related to the acquisition of other customers. Dusenberry, on the other hand, tried to show that most of the buyers seemed to “compete” with each other. The increased level of comfort that has developed in the post-war period makes us want to be better, that is, to surpass our closest neighbors in something. A similar demonstration effect can be seen today. People get loans and buy quite expensive things that, it would seem, do not correlate with their income. The desire to be a little better than in reality is still a priority. A person sacrifices his own comfort and does not act in the most rational way, if only to take his rightful place among the rest.
It turns out that the concept of relative income even contradicts the basic theories of society and consumption. One of the main ideas of the sphere under consideration is violated, namely the principle of rationality. Whether it is worth accepting such a theory as fundamental is a moot point. However, there are certainly reasonable connections and strong evidence.
Life cycle theory
The following concept was developed by the American economist Franco Modigliani in 1954. It is based on the assumption that current consumption is not a function of current income, but total consumer wealth. All buyers, in one way or another, are constantly striving to distribute the acquired goods in such a way that the level of expenses remains constant, and wealth is lost entirely by the end of life. It turns out that for the whole life cycle, the average propensity to consume is equal to one.
The essence of the concept is based on the hypothesis according to which the behavior of buyers throughout their working life should be arranged in such a way that from the generated income it turns out to save some of the funds for material support of the elderly. In youth, people have too much consumption. Often, they do live on credit. At the same time, they hope for a return of the taken amount to mature years. And already by old age, both a pension and the savings of adult children are spent on purchases.
Modigliani's alternative theory of behavior and consumption has been disproved by modern empirical research. For example, take the thesis of an economist from America Jeffrey Sachs.
First, do not forget about the existence of savings formed from precaution. No one bothers a person to form a similar reserve at a young age. Modigliani’s assertion that acquirers who have not reached adulthood, all spend their finances and go into debt as one, can be called extremely subjective and unconfirmed. Moreover, not a single basic theory of society and consumption indicates this.
Secondly, the assumption that he will live longer than planned was rarely laid in the minds of people. People are not used to looking into the future, let alone investing in it. Almost every individual lives in the present tense, and therefore lays a little more on the future than it should. However, this point can be called controversial.
The third thesis is related to the possibility of disease. People remember about possible ailments, and therefore try to take care of their health. In conditions of paid treatment, this can lead to additional, often quite large costs. However, life insurance is extended in modern society, and therefore criticism of this thesis can be partially removed.
The fourth point is related to the desire of the elderly to leave an inheritance. An intelligent person wants to leave some of the material wealth to his children, relatives, and sometimes even charitable organizations. There is a lot of empirical evidence that the savings activity of older people in some countries is slightly lower than that of young workers. In addition, it should be remembered that the accumulated wealth is incomparably greater than what all older people living on earth can spend.
This leads to a simple conclusion. The consumer consumption theory, called the life cycle model, presented by Modigliani, does not fully explain consumer behavior. Obviously, an important factor in saving is considered the desire to provide life in retirement.
