101 Economics - Consumer Theory Easily Explained

Topics: Consumer theory, Utility, Indifference curve Pages: 9 (2721 words) Published: April 19, 2012

From http://www.economicswebinstitute.org/essays/consumertheory.htm

The standard textbook model of consumer is an outstanding example of the neoclassical paradigm in economics [1]: a h y p e r-rational agent maximises something by choosing an "optimal" bundle of things. Here, the hyper-rational consumer maximises utility (i. e. an overall generic measure of well-being) by exhausting a given budget. He has a pre-defined income to spend on - for simplicity's sake - two goods, called X and Y, respectively. He could spend his entire income buying only X, thus purchasing a quantity of X equal to income divided by the price of X. Let's take a numerical example that you find here in the animated graph and that you can replicate with the software: when his income is 50 and the Y price is 10, the consumer can purchase 5 units of Y (higher red point on Y axis). Or he could spend his entire income buying only X - t h e o t h e r g o o d - thus purchasing a quantity of X equal to his income divided by the price of X. If X price is 6, the consumer can purchase at most 8.33 units of X (lower red point). Or he can afford (at most) to buy any combination of quantities of X and Y that costs exactly as the income. These combinations give rise to the budget line you see between the two red points. How to choose? Well, by having a consistent set of judgements about how much utility the consumer will enjoy by consuming each possible bundle of goods.

T h e t y p i c a l w e l l-b e h a v e d s t r u c t u r e o f u t i l i t y o f b u n d l e s i s o f f e r e d b y indifference curves, i.e. all bundles giving the same level of utility to the consumer. Here below you can see two indifference curves: the higher indifference curve is characterised by a higher level of utility.

Now, we should consider - at the same time - both the budget constraint (the budget line) and the utility structure (the indifference curves). T h e optimal bundle of goods belongs to the highest possible indifference curve crossing the budget line.

The red point is the rational consumer's choice (the chosen bundle), since it maximises utility, given the budget constraint. Everything sounds very logical and convincing - within the unrealistic setting offered by this kind of mathematics. The deductive style of this microeconomics in consumer theory takes very little care of empirical analysis and of any reasonably open experimentation. Still, let's now see some numerical examples of what we said.

2.Comparing the neoclassical model with its opposite alternative How do you really choose in a supermarket, facing thousands of goods and brands? Do you have a single figure (utility) attached to any good and any combination of quantities of every good, expressing your future enjoyment? Is your choice completely independent from what others decide or what you have already at home? Is your pocket empty when exiting? Do you exhaust always your budget? Is what you chose "optimal" so that next time, given your unchanged income and the same prices, you'll choose exactly the same thing? Many students at the end of the course in Microeconomics are very sceptical about the realism of the neoclassical theory, especially the part about consumers, since they have direct expericence of buying acts and they know how they choose. And they find no trace of high mathematics and optimisation procedures. They don't use computer software to compute optimal choces.

Evolutionary economics is the main competitor of the mainstream perspective in the micro-f o u n d a t i o n o f consumption. I t h a s a l r e a d y r e a c h e d s o m e clear theoretical foundations as well as formal models (as this). It has been applied to choices in Point of Sales (such as these) Here we present some very schematic comparison of the two approaches.


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